Intuition is not what should lead a business; it is data that should be taken in the highest regard, especially when it is about money. A recent study shows that businesses that are led by data are 23 times more likely to gain customers and 19 times more profitable than businesses that rely on their “hunch”.
Over the years, businesses and their CFOs have been more inclined to make data-driven decision-making. Along with the data revolution, the accounting industry has been witnessing changes in financial technology that have helped bring about innovations in software automation, and artificial intelligence.
In this article, Finsmart Accounting – globally trusted for accounts receivable and playable outsourcing services – will share everything about cash flow analysis and cash flow reporting. We will also be listing tools that will make the task of cash flow analysis easy. Let’s start!
Critical cash flow types
When it comes to understanding the current status and predicting the future of cash flow, it is no exception. For CFOs, it is necessary to identify risk and prepare for consequences based on the data. The process is often termed as cash flow analysis.
There are three types of cash flow that businesses should track and analyze:
– Cash flow from operating activities
– Cash flow from investing activities
– Cash flow from financing activities
Why should CFOs conduct a cash flow analysis?
The amount of money available for the business to conduct its operations and make payments – this is what a cash flow analysis helps understand. The calculation is current assets (cash or near-cash assets) minus current liabilities (liabilities in the upcoming accounting period).
For a CFO who handles the end-to-end finances of a business, cash flow analysis is essential to understand if the business can pay the bills and continue to generate cash for operations, pay its vendors and employees, etc. If the negative cash flow situation persists for a long time, it might be a sign that the business is moving towards bankruptcy.
Before we get into the details of cash flow analysis, let us understand what leads to inefficient cash flow management.
Reasons behind inefficient cash flow management
Inefficient cash flow management can herald a lot of problems. Here are the major reasons behind inefficient cash flow analysis and management:
1. Seasonal trends: Businesses evolve and change in every season. This is especially true for B2B businesses. For some firms, the summer months are slower; for others, it’s the holiday season. For CFOs, it is important to catch the trends in advance as this impacts cash flow. Just like an unexpected shortage of cash leads the firm to unimaginable troubles, so does over flow of cash. Businesses end up making unnecessary expenditures and not-so-important investments when there is a surplus. By the time the CFO catches on to the present, unforecasted data, they would already be posed with a new set of data.
2. Lack of necessary information: For a CFO, it is important to know what information is needed and how it should be used. Data-driven analysis is not just about having one piece of information. It is about having everything that is needed. Breaking down the available data into smaller pieces helps develop a cash strategy that fits the organization’s needs better.
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3. Rigid tools: For the longest time, finance professionals, including CFOs swore by Excel to solve their number woes. It is a great tool for maintaining data, but it is most certainly not the tool you could seek when building a long-term forecast plan. The tech of the spreadsheets is limiting, but there are so many options out there to get the support you need.
4. Limitations: Differences in time and time zones, availability of skilled resources, and access to software for quick completion of tasks are some of the top hindrances that CFOs face. This leads them to spend too much manual time on report creation. And if that is the case, the team most likely will not have much time for strategizing the firm’s moves.
Cash Flow Analysis Tips and Recommendations
Now that we understand the reasons for hindrances in cash flow management, let us understand the steps involved in cash flow analysis:
1. Target positivity in cash flow: As a CFO, your focus should be making operations grow sustainably with as little cost involved as possible. When operating income exceeds net income, it is an indicator.
2. Take risks for positive cash flow: Be mindful of the risks that the business might be taking when it comes to cash flow and its risks. Positive cash flow for investment purposes and negative cash flow in the operations do not signify the outcome you are looking for. Most often, in such cases, the business is selling off assets to meet the operating expenses. It’s probably time to change strategy.
3. Be critical of the negative cash flow: A negative cash flow could mean a lot of things and it is not necessarily bad. It is also equivalent to investments and expenditure in making products, building infrastructure, etc. That is why, it is important to conduct a thorough analysis of the cash flow. A positive cash flow in operation and a negative one in investments denotes growth.
4. Calculate the available cash flow: Free cash flow is what is available after payment of operational and capital expenditures. This remaining cash can be used for all ad-hoc expenses like buying stocks, acquiring another company, principal payments, and so on.
5. Operating cash flow margins: The operating cash flow margin ratio measures the cash from operating activities as a percentage of sales revenue. Having a positive margin showcases profit, efficiency, and quality in earnings.
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How can CFOs assess and enhance cash flow reporting
Real-time Transparency
– Use a centralized financial management platform for real-time visibility of cash position
– Use cloud-based software to track cash movements, and monitor liquidity levels and cash shortfalls
Cash flow forecasting and analysis
– Build a forecast model including historical data, current trends, and future projections to optimize liquidity
– Create a scenario analysis to assess the impact of economic scenarios, market fluctuation, and enabling risk mitigation strategies
Optimization of workflow capital
– Analyze metrics like Days Sales Outstanding, Days Payables Outstanding, and Inventory Turnover to optimize conversion cycles
– Streamline AR processes, negotiate to terms that favor the business, and optimize inventory levels
KPIs and Cash Flow Ratios
– Monitor Cash Conversion Cycle, Operating Cash Flow Ratio, and Free Cash Flow to Sales ratio since it greatly helps assess financial health.
– Establish KPIs that meet organizational objectives and drive constant improvement
Risk Management and Emergency Planning
– Identify cash flow risks such as credit defaults, supply chain issues, regulatory changes and market volatility
– Build contingency plans to address expected cash flow disruptions, to ensure the continuation of operations in difficult times
Compliance knowledge
– Stay aware of the changing regulatory requirements related to cash flow management, liquidity risk management
– Conduct audits and internal reviews to assess the effectiveness of internal processes, cash flow management, and reporting
Continuous Monitoring and Evaluation
– Establish a process of continuous monitoring and review of cash flow performance, and underlying drivers to identify opportunities for strategic adjustments
– Conduct regular reviews and benchmarking exercises against industry best practices to stay in the forefront of cash flow management
Accurate Reporting and Communication
– Develop dashboards and reports that allow you (CFO), the team, and the management to get a holistic view of the cash flow metrics and financial health of the business before making decisions
– Always maintain clear, transparent, and effective communication with the stakeholders including board members, investors, and auditors to maintain trust and keep everyone on the same page about the business’s financial health
Best Tools for Cash Flow Management
Cash flow management becomes easy when you have the right tools. Such software not only makes the task easy but also helps reduce dependency on others to get the job done. Here are the top cash flow management software that CFOs can use:
– Cube
– Anaplan
– Workday Adaptive Planning
– Centage
– Causal
– Jirav
Efficient cash flow management with Finsmart
An effective cash flow management system is critical for global CFOs. As they continue to navigate through the complexity of the financial world, this becomes imperative. However, as a CFO, it is important to remember that making correct financial decisions depends upon the insights that you bring to the table. Hence, making the right use of data to gain real-time visibility, forecasting, and risk management is extremely important.
Struggling with managing cash flow? Outsource your accounting tasks with Finsmart Accounting.
Write to us at connect@finsmartaccounting.com.
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Director Growth Strategy & Alliance
Maanoj Shah is a finance and outsourcing expert with strong Business Strategy and Scaling-up experience. Over the last 20 years, he has incubated multiple businesses and helped build global enterprises in verticals as diversified as hospitality, technology, and healthcare.
