Cash flow is one of the main reports produced by the accounting function through business accounting software. This report reveals how the company spends its money (outflows) and from which sources this money comes (inflows). The company can rely on the statement of cash flows to determine how well its operations generate cash and to predict its potential to generate cash in the future.
The statement of cash flows categorizes the company’s cash activities into three categories: operating, financing, and investing activities. Cash flows from operating (CFO) show the amount of money the company receives and pays due to regular business activities. Examples of CFO items are sales, purchases, amortization, and depreciation. Meanwhile, cash flow from investing (CFI) involves the acquiring and selling of capital assets like factories, buildings, and land. Cash flow from financing (CFF) refers to the movement of funds between the company and the owners, investors, or creditors.
When doing a cash flow analysis, business owners identify relationships among the items and categories. Entrepreneurs usually quantify these relationships using ratios and indicators, allowing them to evaluate and compare business performance. From this, they can draw conclusions about the company’s situation and use it to make relevant decisions.
Operating Cash Flow Ratio
The operating cash flow ratio is derived by dividing the net items in the CFO by the total short-term liabilities. This ratio also helps gauge liquidity or the company’s ability to cover currently maturing liabilities using the cash flows from operations.
An operating cash flow ratio greater than 1 indicates that the company has more cash than what is necessary to pay current liabilities. On the other hand, a lower ratio means that it does not have enough cash to cover maturing liabilities, suggesting that it may need more capital.
Cash Flow to Sales Ratio
This ratio allows for a comparison between the operating cash flows and sales. It is computed by dividing the CFO by the net sales. Ideally, the company’s cash flow to sales ratio should be positively proportional to sales. If the resulting number shows otherwise, it could mean that the entity is having issues.
A declining cash flows to sales ratio suggests that the firm is increasing its sales by delaying cash inflows. For one, it could indicate that the receivables from credit sales are taking longer to convert into cash. Or it could mean that its sales promotion campaigns are not effective.
Free Cash Flow
Free cash is the amount of cash available after deducting operations and capital expenses. It is important as it shows how productive the company is at generating cash flows. Companies usually use free cash to pay dividends, share buybacks, and other necessities. Free cash flow is computed by deducting the capital expenses from the net operating cash flow.
Accounting Software That Supports Proper Cash Flow Analysis
Proper cash flow analysis is achieved only with accounting records that provide an accurate and fair representation of the financial activities. A comprehensive yet simple business accounting software is therefore critical so the business owners can make relevant decisions.
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