Cash flow analysis refers to the evaluation of inflows and outflows of cash in an organisation obtained from financing, operating and investing activities. In other words, we can say that it determines the ways in which cash is earned by the company.
It measures how much cash is generated and spent on the business during a given accounting period.
While performing a cash flow analysis, the business needs to check all the line items that come under the three cash flow categories to find out if the flow of capital is coming in or going out.
Also see: What is Cash Flow Statement?
Cash flow analysis can be performed by analysing the following activities:
1. Cash flow from operations or operating activities: In this type of cash flow the cash inflow is generated from the internal activities. In other words, the cash flow is generated from the normal business operations. The examples of such activities are rent, salaries for the employees.
2. Cash flow from investing activities: Cash flow from investing activities are mostly focused on purchase (outflow) or sale of fixed assets (inflow), or on capital investments like purchase (outflow) or sales of stocks and securities of another company (inflow).
3. Cash flow from financing activities: Cash flow from financing activities include buying back of shares, issuing of stock. The activities of borrowing or repaying of loans is also a part of the cash inflow and outflow from the business. Dividend payments can also be considered as a part of the cash flow from the financing activities.
Also read: MCQs on Cash Flow Statement
Cash flow analysis is important due to the following reasons:
Cash flow analysis helps in determining the working capital of a firm which is very essential for running the business. Working capital is referred to as the money available to run the business and is calculated by subtracting the current liabilities from the current assets.
It provides a view of the liquidity position of the business and its capability to maintain its operations.
This concludes our article on the topic of Cash Flow Analysis, which is an important topic in Accountancy for Commerce students. For more such interesting articles, stay tuned to BYJU’S.