Cash flow is the amount of cash and cash equivalents, such as securities, that abusiness generates or spends over a set time period. Cash on hand determines acompany’s runway—the more cash on hand and the lower the cash burn rate, themore room a business has to manoeuvre and, normally, the higher its valuation.
Cash flow differs from profit. Cash flow refers to the money that flows in and out ofyour business. Profit, however, is the money you have after deducting your businessexpenses from overall revenue.
What Is Cash Flow Analysis?
There are three cash flow types that companies should track and analyse to determine theliquidity and solvency of the business: cash flow from operating activities, cash flowfrom investing activities and cash flow from financing activities. All three areincluded on a company’s cash flow statement.
In conducting a cash flow analysis, businesses correlate line items in those three cashflow categories to see where money is coming in, and where it’s going out. Fromthis, they can draw conclusions about the current state of the business.
Depending on the type of cash flow, bringing in money in isn’t necessarily a goodthing. And, spending money it isn’t necessarily a bad thing.
Video: What Is Cash Flow Analysis?
Key Takeaways
- Cash flow analysis helps you understand how much cash a business generated or usedduring a specific accounting period.
- Understanding cash sources and where your cash is going is essential for maintaininga financially sustainable business.
- A business may be profitable and still experience negative cash flow or lose moneyand experience positive cash flow.
- Complementary measurements, such as free cash flow and unlevered free cash flow,offer unique insights into a company’s financial health.
Cash Flow Analysis Explained
Cash flow is a measure of how much cash a business brought in or spent in total over aperiod of time. Cash flow is typically broken down into cash flow from operatingactivities, investing activities, and financing activities on the statement of cashflows, a common financial statement.
While it’s also important to look at business profitability on the incomestatement, cash flow analysis offers critical information on the financial health of acompany. It tells you if cash inflows are coming from sales, loans, or investors, andsimilar information about outflows. Most businesses can sustain a temporary period ofnegative cash flows, but can’t sustain negative cash flows long-term.
Newer businesses may experience negative cash flow from operations due to high spendingon growth. That’s okay if investors and lenders are willing to keep supporting thebusiness. But eventually, cash flow from operations must turn positive to keep thebusiness open as a going concern.
Cash flow analysis helps you understand if a business’s healthy bank accountbalance is from sales, debt, or other financing. This type of analysis may uncoverunexpected problems, or it may show a healthy operating cash flow. But you don’tknow either way until you review your cash flow statements or perform a cash flowanalysis.
In addition to looking at the standard cash flow statement and details, it’s oftenalso useful to calculate different versions of cash flow to give you additionalinsights. For example, free cash flow excludes non-cash expenses and interest paymentsand adds in changes in working capital, which gives you a clearer view of operating cashflows. Unlevered free cash flow shows you cash flow before financial obligations whilelevered free cash flow explains cash flow after taking into account all bills andobligations.
Depending on the size of your company, your financial situation, and your financialgoals, reviewing and tracking various forms of cash flow may be very helpful infinancial planning and preparing for future quarters, years, and even a potentialdownturn in sales or economic conditions.
Why Is Cash Flow Analysis Important?
A cash flow analysis determines a company’s working capital — the amount ofmoney available to run business operations and complete transactions. Thatis calculated as (opens in a new tab)current assets (cash or near-cash assets, like notes receivable) minus currentliabilities (liabilities due during the upcoming accounting period).
Cash flow analysis helps you understand if your business is able to pay its bills andgenerate enough cash to continue operating indefinitely. Long-term negative cash flowsituations can indicate a potential bankruptcy while continual positive cash flow isoften a sign of good things to come.
Cash Flow Analysis Basics
Cash flow analysis first requires that a companygenerate cash statements (opens in a new tab)about operating cash flow, investing cash flow and financing cash flow.
- Cash fromoperating activitiesrepresents cash received from customers less the amount spent on operating expenses.In this bucket are annual, recurring expenses such as salaries, utilities, suppliesand rent.
- Investing activitiesreflect funds spent on fixed assets and financial instruments. These are long-term,or capital investments, and include property, assets in a plant or the purchase ofstock or securities of another company.
- Financing cash flowis funding that comes from a company’s owners, investors and creditors. It isclassified as debt, equity and dividend transactions on the cash flow statement.
How Do You Perform Cash Flow Analysis?
To perform a cash flow analysis, you must first prepare operating, investing andfinancing cash flow statements. Generally, the finance team uses the company’saccounting softwareto generate these statements. Alternately, there area number of free templates available. (opens in a new tab)
Preparing a Cash Flow Statement
Let’s first look at preparing the operating cash flow statement. The line itemsthat are factored into the company’s net income and are included on thecompany’s operating cash flow statement include but are not limited to:
- Cash received from sales of goods or services
- The purchase of inventory or supplies
- Employees’ wages and cash bonuses
- Payments to contractors
- Utility bills, rent or lease payments
- Interest paid on loans and other long-term debt and interest received on loans
- Fines or cash settlements from lawsuits
There are two common methods used to calculate and prepare the operating activitiessection of cash flow statements.
The Cash Flow StatementDirect Methodtakes all cash collections from operating activities and subtracts all of the cashdisbursem*nts from the operating activities to get the net income.
The Cash Flow StatementIndirect Methodstarts with net income and adds or deducts from that amount for non-cash revenue andexpense items.
The next component of a cash flow statement is investing cash flow. That bottom line iscalculated by adding the money received from the sale of assets, paying back loans orselling stock and subtracting money spent to buy assets, stock or loans outstanding.
Finally, financing cash flow is the money moving between a company and its owners,investors and creditors.
Cash Flow Analysis Example
Net income adjusted for non-cash items such as depreciation expenses and cashprovided for operating assets and liabilities.Using a free public template from the Small Business Administration (SBA), let’ssay Wild Bill’s Dog Trainers and Walkers had a net income of $100,000 to start andgenerated additional cash inflows of $220,000.
As you can see in the spreadsheet, it spent $41,000 on operating cash outflows likehiring an additional person, buying new equipment for the dog park, paying taxes andmore. The owner paid some principal down on a loan and took a draw of $50,000 for anending cash balance of $127,200. Small changes in any of those line items show theimpact of hiring more people, paying more taxes, buying more equipment and more toensure the business has a healthy balance sheet and doesn’t go “into thered.”
Wild Bill’s Dog Trainers and Walkers
| [Month] | [Month] | [Month] | [Month] | [Month] | [Month] | Total | ||
|---|---|---|---|---|---|---|---|---|
| Beginning Cash Balance | 100,000 | $127,200 | ||||||
| Cash Inflows (Income): | ||||||||
| Accts. Rec. Collections | 80,000 | 80,000 | ||||||
| Loan Proceeds | 20,000 | 20,000 | ||||||
| Sales & Receipts | 20,000 | 20,000 | ||||||
| Other: | 0 | |||||||
| Total Cash Inflows | $120,000 | $0 | $0 | $0 | $0 | $0 | $120,000 | |
| Available Cash Balance | $220,000 | $127,200 | ||||||
| Cash Outflows (Expenses): | ||||||||
| Advertising | 100 | 100 | ||||||
| Bank Service Charges | 100 | 100 | ||||||
| Credit Card Fees | 500 | 500 | ||||||
| Delivery | 0 | 0 | ||||||
| Health Insurance | 4,000 | 4,000 | ||||||
| Insurance | 1,000 | 1,000 | ||||||
| Interest | 1,000 | 1,000 | ||||||
| Inventory Purchases | 5,000 | 5,000 | ||||||
| Miscellaneous | 300 | 300 | ||||||
| Office | 200 | 200 | ||||||
| Payroll | 8,000 | 8,000 | ||||||
| Payroll Taxes | 20,000 | 20,000 | ||||||
| Professional Fees | 100 | 100 | ||||||
| Rent or Lease | 1,000 | 1,000 | ||||||
| Subscriptions & Dues | 200 | 200 | ||||||
| Supplies | 100 | 100 | ||||||
| Taxes & Licenses | 100 | 100 | ||||||
| Utilities & Telephone | 100 | 100 | ||||||
| Other: | 0 | 0 | ||||||
| Subtotal | $41,800 | $0 | $0 | $0 | $0 | $0 | $41,800 | |
| Other Cash Out Flows: | ||||||||
| Capital Purchases | 0 | 0 | ||||||
| Loan Principal | 1,000 | 1,000 | ||||||
| Owner’s Draw | 50,000 | 50,000 | ||||||
| Other: | 0 | |||||||
| Subtotal | $51,000 | $0 | $0 | $0 | $0 | $0 | $51,000 | |
| Total Cash Outflows | $92,800 | $0 | $0 | $0 | $0 | $0 | $92,800 | |
| Ending Cash Balance | $127,200 | $127,200 | ||||||
This automated form is made available compliments of CCH Business Owner’sToolkit
Five Steps to Cash Flow Analysis
There are a few major items to look out for trends and outliers that can tell you a lotabout the health of the business.
- Aim for positive cash flow
When operating income exceeds net income, it’s a strong indicator of acompany’s ability to remain solvent and sustainably grow its operations. - Be circ*mspect about positive cash flow
On the other hand, positive investing cash flow and negative operating cash flowcould signal problems. For example, it could indicate a company is selling offassets to pay its operating expenses, which is not always sustainable. - Analyse your negative cash flow
When it comes to investing cash flow analysis, negative cash flow isn’tnecessarily a bad thing. It could mean the business is making investments inproperty and equipment to make more products. A positive operating cash flow and anegative investing cash flow could mean the company is making money and spending itto grow. - Calculate your free cash flow
What you have left after you pay for operating expenditures and capital expendituresis free cash flow. This can be used to pay down principal, interest, buy back stockor acquire another company. - Operating cash flow margin builds trust
The operating cash flow margin ratio measures cash from operating activities as apercentage of sales revenue in a given period. A positive margin demonstratesprofitability, efficiency and earnings quality.
Cash flow analysis helps your finance team better manage cash inflow and cash outflow,ensuring that there will be enough money to run—and grow—the business.
Analyse Cash Flow With Software
The math behind a free cash flow analysis can be complex, particularly for largecompanies or those with complex finances. However, bookkeeping or accounting software,sometimes part of a larger ERP, take care of much of the heavy lifting for you. Onceyour reports are setup in an ERP like Oracle NetSuite, your cash flow, free cash flow,and other numbers, and the underlying details, are just a few clicks away.
Large companies employ teams of financial planning and analysis (FP&A) professionalswho spend their entire workday digging into the details of financial results looking forpatterns and opportunities to improve results. With a powerful ERP available, much ofthat process is automated, allowing you to do more with fewer staff.
Small businesses and large enterprises alike should understand their cash flow and cashposition with regular check-ins. NetSuite helps you achieve better results throughautomated reporting, machine learning and AI-driven analysis, and extensive financialanalysis tools to give you accurate, timely information about your business.
Cash Flow Analysis Is Critical for Every Business
Savvy investors would never buy the stock of a company without first looking at itsfinancial statements, including cash flow. A more detailed cash flow analysis —provided throughERP and advanced accounting software— offers insights into the financial health and future performance of a business.Business owners, managers, and executives should look at similar data on their companieson a regular basis to ensure it’s on track to meet its short-term and long-termfinancial goals.
Cash flow and cash flow analysis are important for virtually every business. Workingwithout cash flow knowledge is like a pilot flying blind. Never run your businesswithout updated, accurate cash flow data.
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Cash Flow Analysis FAQs
What is cash flow analysis with an example?
Cash flow analysis is a method of reviewing cash flow details for a business. An examplemay be as simple as looking at the latest cash flow statement or require more complexcalculations, ratios, and comparisons.
What is the purpose of cash flow analysis?
Cash flow analysis helps business owners, managers, executives, lenders, andshareholders understand if a company is generating cash or using cash, and the breakdownof where those cash movements are happening in the company.
How do you analyse cash flow?
Cash flow analysis typically begins with the statement of cash flows, which breaks downcash flows into sections for operating, financing, and investing activities. Analysisincludes looking for trends, areas of strong performance, cash flow problems, andopportunities for improvement.
What is cash flow software?
Cash flow software is software that helps calculate and analyse cash flow. Bookkeepingsoftware, accounting software, and ERP software typically include cash flow softwaremodules or components.
What is a cash flow analysis?
Cash flow analysis is a review of business cash flows with a goal of finding trends oropportunities that allow for improved business decisions and improved long-term growthand sustainability.
What tools do you currently use to manage cash flows?
Most business leaders looking to manage cash flows use their ERP or accounting softwareas a key tool, such as Oracle NetSuite. They may also use spreadsheet software tocomplement analysis and research.
