Cash flow | 10 min read

Cash flow analysis made simple

cash flow
Cash flow analysis is a common hurdle business owners face, especially in the trades industry. It’s a common suggestion, brought up when a business isn’t earning enough money –or any money at all– and owners need to know why.

Those why’s can be answered through a closer look at a business’ cash flow.

Picture this: the collective income your company earned for a month’s worth of renovations was unable to cover the costs of materials and labour. Or maybe your contracting rates are unable to make up for inventory purchases. The problem with such situations is that the amount of money you’re currently earning isn’t commensurate to what you are currently spending.

You might be facing a cash flow problem, wherein you don’t fully appreciate how money enters and exits your business. Keeping your earning and spending in check is crucial to the success of your business.

Overestimating your current capacity to spend might lead you to splurge on new equipment without thinking, and being overly optimistic about your income might cause you to give bonuses you shouldn’t be giving. Either scenario is unsustainable for long-term business.

To help you avoid overspending, under-charging, and the gamut of cash flow-related issues, this short guide will take you through the following:

  1. Basic cash flow analysis concepts
  2. The importance of cash flow analysis
  3. Examples of cash flow analysis for tradies, and
  4. Some key indicators to look out for.

What is cash flow?

Cash flow is literally defined as “the net amount of cash and cash-equivalents being transferred into and out of a business”. In layman terms, it simply means the cash earned and spent by your business.

Cash flow can be viewed in three different ways:

  1. As revenue minus costs
  2. As liquidity and
  3. As a circuit

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Put plainly, “revenue minus costs” pertains to the net amount your business is earning, which can be computed as the difference between the total amount you receive for services rendered and goods sold, minus any expenses and disbursements made. A nuanced of this view of cash flow is that it refers to current cash on hand, as opposed to being an accrued amount (no debts are counted).

Calculating revenue minus costs allows you to distinguish the money that flows in your business from the actual amount you earn. As an example, you could be earning a lot in absolute figures, say $750k per year, but you could also be spending more than you earn. Remember that money flows both in and out of your business. Understand this and you’ll have a more realistic picture of how much money your business actually generates.

The next perspective on cash flow, liquidity, has a lot to do with the first. For those unfamiliar with the concept, liquidity is the combined value of liquid assets under your business. These could come in the form of cash or assets that are about as good as cash. In a way, liquidity is the amount your business can afford to spend at any given time –and business really only ought to spend as much as it can immediately pay.

Liquidity is a common problem in the trades industry because people mistakenly equate income with cash. Your business might be raking in profit while steadily losing the ability to make good on payments. This is a result of the all-too-common reality that payments in the trades industry take a while to process. In other words, money often comes in slower than you can afford.

It could be because repair and construction projects take a while to close, or that clients remain under accounts receivable while payment is being processed. Whichever the case, liquidity is the aspect of cash flow that defines the limits to your spending.

The two views come together when you think of cash flow as a circuit. That is, as a life-force that invigorates processes and enables actions—almost like an electric current that runs through everything you do.

In the same manner that power enters and exits an electrical circuit, money enters a business by way of payments and exits by way of expenses such as rent, salaries, taxes, equipment, and the like. Note that what you spend on is just as important as what you earn. Without spending, you wouldn’t be able to invest in a proper office, hire competent tradies, or even get the right materials for the job. Without earning, well, you’d have absolutely no money to spend.

Knowing how much you’re earning and how much you can spend allows you to gain a better, more realistic view of your business. That said, understanding cash flow is pivotal to a tradie’s success—it can spell the difference between growing a profitable business and going bankrupt.

Now that we understand cash flow and its importance, let’s discuss cash flow analysis.

What is a cash flow analysis?

Cash flow analysis is an assessment of your business’ income and expense streams—or the analysis of your cash flow, as the name implies. It calls for a careful evaluation of the different components of your business that affect cash flow. Some examples of this are inventory, accounts payable, and accounts receivable, which can also be expressed as a comparison between periodic expenses and periodic income.

Being able to conduct cash flow analysis is particularly useful for tradies involved in landscaping or construction. In those fields, the ability to do work and, consequently, generate income is a function of the weather. If the weather is good, people can work and earn; if not, well, then everyone is on break and business is put on hold.

How can tradies in those businesses hedge for bad weather, should it arise?

Cash flow analysis can prove a useful tool in these cases. If you know how much cash goes in and out of your business at any given time period, you’ll be able to better handle your funds in the case of bad weather, late payments, or even a slow month. Using cash flow analysis can make it a little (or a lot) easier to predict events and, in the process, manage them.

So how can it be done? Well, cash flow analysis can be a technical process, so you might want to keep your accountant handy. But the basics of it are definitely doable and learnable right now.

Conducting a cash flow analysis

There are a lot of technical terms when it comes to the process of analysing your cash flow but don’t let that intimidate you. A cash flow analysis can be as straightforward as listing down the various amounts spent in a given period alongside the cash earned in the same time. From even just this point on you should be able to efficiently monitor your cash flow.

To sophisticate and improve the accuracy of the analysis, you can utilise a cash flow report or cash flow statement. This examines the changes to your cash reserves due to different business activities, as well as increases or decreases in other accounts on your balance sheet. In simpler terms, it’s a statement which notes the inflow of cash from specific sources and the outflow of cash for particular expenditures.

There are three parts to a cash flow statement: operating activities, investing activities and financing activities. Operating activities applies to regular business operations which affect the flow of cash. This refers to things like stocking the inventory and accepting payment for a project. Investing activities for tradies could mean the cost of investing in equipment or tools and the amount (hopefully) gained from that in the long-term.

While financing activities is related to your capital. Borrowing loans or selling stocks would count as inflow, and paying back said loans or buying back those stocks would be an outflow.

A cash flow analysis which takes this all into account isn’t just useful for tracking the progress of the business, but for setting a path to growth. It allows for the proper projection and budgeting of your cash flow.

To ensure that things are going right, look out for a balanced cash flow or a consistent increase in positive cash flow. Both point at growth for the company. Try to keep an eye out for a swelling accounts receivable. While it may bode well for the future, the promised amount will not do your cash flow any favours. Loan advances which are maxed out too quickly should raise some red flags, too. This could mean spending too much, too fast, and without the means to pay it back.

Conclusion

Cash flow analysis is key for a business that hopes to grow and maintain that growth. This might all seem like a lot of information and a bit of pressure, but just take things a step at a time. Track your expenses and your income, make a statement, and stay aware of key indicators when conducting the analysis and to keep yourself on track.

Cash flow template

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