“Cash is king.”
I’m sure you’ve heard that before. Any accountant or business owner will tell you that understanding and regularly analyzing your cash flow is crucial in keeping your finger on the pulse of your company’s health. Cash flow analysis is critical in managing liquidity: it tells you the health of your liquid assets and if you’re in a liquidity crunch or not. Understanding your liquidity and your cash flow will give you metrics on profitability and whether or not you’re hitting targets.
What Is a Cash Flow Analysis?
A proper cash flow analysis is the cornerstone of getting and keeping companies on the right track. It’s often challenging, it’s often time-consuming and it can be costly because of how much time it takes to gather all the important information and get a true feel of the health of the business.
In essence, a cash flow analysis is an evaluation of a company’s cash inflows and outflows during a specified period. It’s not just recording how much you earn and how much you pay; cash flow can be significantly different from a straightforward accounting of income and expenses. Depending on invoicing terms a company might give to its customers, it could sell $100,000 worth of products or services in a month but only receive $25,000 in payment. A cash flow analysis looks at what you’ve actually been paid out of what you’re owed (accounts receivable) and what you’ve paid toward your own expenses (accounts payable), giving a clearer picture of what a company actually has to work with.
Analysis in Action
The firm I co-founded and serve as a principal for, Percipio, provides financial consultant services for a number of client organizations. In that capacity, we always take a deep dive into their books, which includes a cash flow analysis. That can be a challenge, particularly for small businesses, because sometimes a company’s bookkeeping methodology basically consists of a folder of receipts and a folder of bank deposits — that’s their cash flow statement. It falls to us to put together a streamlined analysis of their cash flow statements and a proper accounting of the way that they’re running their business.
But we’ve received a tremendous amount of positive feedback as to how that baselines these organizations. We can walk them through the budget creation and budget analysis process all the way to more in-depth financial modeling, which helps them move forward to better manage their business and their profitability (or lack thereof).
A rigorous cash flow statement analysis isn’t just for instituting fiscal best practices in a company that needs some help. Even in a well-performing and established organization, regular cash flow analysis is necessary to maintain operational health.
At Percipio, one of our strengths is residential real estate investing. We’ve been doing it for years, so we know our way around this asset class. But we still run through regular cash flow analysis for each property investment, on at least a monthly basis. It gives us insight in terms of managing cash flow during seasons that are typically difficult for real estate, such as property tax cycles and the low season for lease-ups.
Case Study: Managing Real Estate Liquidity Through Cash Flow Analysis
A few years ago, a Percipio subsidiary, HD-Omaha, was doing a renovation project that was targeted to come to market in late spring — just in time to capitalize on the high season for lease-ups. Our financial modeling was based on this asset coming to market in early June, and we had projected rents and occupancies based on that forecast. Due to a combination of circumstances, some that were in our control and some that were not, the project wasn’t completed until mid-October — past the high lease-up season and into the low. On top of that, it wound up 30% over budget.
At that point, we were strapped for liquidity on the project. Between being over budget and also knowing we’d have a difficult time leasing up at that point in the year, it could have been significantly challenging if we hadn’t been astute and prudent, planning properly for “what-if” scenarios.
Yes, it pinched us. But we have always been prudent at managing our cash flow and our liquidity. We do critical cash flow analysis on a continual basis — at least monthly, but we’ll do it weekly or daily if we’re riding the edge — and run projections and what-if scenarios. Based on the numbers we get through these analyses, we ensure our bases are covered in terms of cash flow, liquidity and operating lines of credit should we find ourselves in a crunch.
So while the above situation wasn’t ideal, having kept a close eye on cash flow throughout the whole process meant we were able to weather the lean time and maintain the investment until it caught up to our projections.
But a regular and thorough analysis of cash flow statements can do so much more than help see you through a liquidity crunch. It can also provide assistance in another key area for businesses: market trend forecasting. On its own, it won’t give you a complete picture, but when you incorporate cash flow analysis in a broader assessment of market trends, you can gain incredibly valuable insight.
Defining Market Trend Analysis
At a high level, market trend analysis involves analyzing data that identifies trends in what people want. Within that framework, a lot of it comes down to supply and demand and related inherent nuances. What is already available in the market? What does the target customer want? By getting valid historical data and subjecting it to a thorough analysis, you can use it to forecast assumed trends and changes in markets.
There are many tools available, both qualitative and quantitative, to develop a market trend forecast. You can conduct market research, often through polls and surveys, evaluate the success of product offerings currently in the marketplace, gather expert opinions and analyze available statistical data. To do that well, you should draw on market publications and industry data, and you need to verify that your data matches up with industry-wide market data. And thanks to social media, it is easier than ever to engage a consumer base to determine what works, what’s failing and where there are perceived gaps in the market.
Why Incorporate Cash Flow Analysis in a Market Trend Forecast?
When you’re researching an established business as an investment target, you want to make sure that it’s going to provide you with a strong ROI while your capital is tied up in it. What products or services does the company offer? Do consumers want what it is selling? And even more importantly, will they continue to want what the company is selling for months or years down the road?
It’s impossible to answer those types of future questions with complete accuracy but evaluating the company’s cash flow will help give insight into future probabilities. A company with a strong cash flow shows the ability to continue earning money; cash on hand can be an indicator of a healthy company at that time, but regular cash inflows indicate that the company has a better chance of staying healthy into the future.
Applying Cash Flow Analysis to Market Trend Forecasting
I mentioned the need to run through regular cash flow analysis for Percipio’s residential real estate investments. For this asset class, we absolutely require regular cash flow analysis to help us see trends in where demand peaks and where it diminishes.
Cash flow will certainly give us insight into market demands and supply on the market. Typically, the late fall and winter months are relatively slow periods for HD-Omaha, whereas spring and summer are relatively busy seasons for us in terms of rental market, in terms of demand and in terms of increasing our cash flow. So as a forecasting tool, cash flow analysis certainly gives us insight into demand, which then helps inform our marketing strategy — we probably won’t put a lot of effort into the low part of the cycle, but we’ll definitely invest significant time and effort into the high part of the cycle to maximize our lease-up. And we can apply the analysis to future real estate opportunities — perhaps a particular property’s location or other factors give it a different seasonality than we are used to in the markets we have primarily focused on. We’d be playing a dangerous game if we simply assumed the same trend data applied universally without subjecting each property to a cash flow statement analysis.
When we are looking at target investment opportunities, cash flow analysis gives us a leg up on forecasting market trends for operating companies. We will analyze companies’ cash flow statements to see what their incoming cash flow looks like, but we can also evaluate their liabilities and make sure the leadership is spending money prudently. You don’t want to invest in a company where the executive team spends money like sailors — they might be bringing in significant positive returns now, but that behavior doesn’t breed confidence in the discipline required to see them through lean times. And there will always be lean times.
When you’re ready to invest your own capital into an organization, you want to make sure you do so with complete trust — both in the leadership and in the market’s demand for the organization’s products or services. Running through a detailed cash flow analysis will help you determine whether that trust is deserved or not.
When it comes to forecasting market trends, there is no single instrument that will let you absolutely nail every time. Each tool you use will give you insights; using them all in a thoughtful combination gives you the best chance of success. But you’d be remiss to leave cash flow analysis out of your trend forecasting toolkit.
And if you want to learn more about how to apply a cash flow analysis to your trend forecasts (or even discover the benefits of regular cash flow analysis for your company), connect with me.