Cash flow is the amount of cash and cash equivalents, such as securities, that a business generates or spends over a set time period. Cash on hand determines a company’s runway—the more cash on hand and the lower the cash burn rate, the more room a business has to maneuver and, normally, the higher its valuation.

Cash flow differs from profit. Cash flow refers to the money that flows in and out of your business. Profit, however, is the money you have after deducting your business expenses from overall revenue.

Video: What Is Cash Flow Analysis?

What Is Cash Flow Analysis?

There are three cash flow types that companies should track and analyze to determine the liquidity and solvency of the business: cash flow from operating activities, cash flow from investing activities and cash flow from financing activities. All three are included on a company’s cash flow statement.

In conducting a cash flow analysis, businesses correlate line items in those three cash flow categories to see where money is coming in, and where it’s going out. From this, 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 good thing. And, spending money it isn’t necessarily a bad thing.

Cash Flow Analysis Basics

Cash flow analysis first requires that a company generate cash statements about operating cash flow, investing cash flow and financing cash flow.

Cash from operating activities represents cash received from customers less the amount spent on operating expenses. In this bucket are annual, recurring expenses such as salaries, utilities, supplies and rent.

Investing activities reflect 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 of stock or securities of another company.

Financing cash flow is funding that comes from a company’s owners, investors and creditors. It is classified as debt, equity and dividend transactions on the cash flow statement.

Why Is Cash Flow Analysis Important?

A cash flow analysis determines a company’s working capital—the amount of money available to run business operations and complete transactions. That is calculated as current assets (cash or near-cash assets, like notes receivable) minus current liabilities (liabilities due during the upcoming accounting period).

Analysis of working capital provides a snapshot of the liquidity of the business.

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How Do You Perform Cash Flow Analysis?

To perform a cash flow analysis, you must first prepare operating, investing and financing cash flow statements. Generally, the finance team uses the company’s accounting software to generate these statements. Alternately, there are a number of free templates available.

Preparing a Cash Flow Statement

Let’s first look at preparing the operating cash flow statement. The line items that are factored into the company’s net income and are included on the company’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 activities section of cash flow statements.

The Cash Flow Statement Direct Method takes all cash collections from operating activities and subtracts all of the cash disbursements from the operating activities to get the net income. The Cash Flow Statement Indirect Method starts with net income and adds or deducts from that amount for non-cash revenue and expense items.

The next component of a cash flow statement is investing cash flow. That bottom line is calculated by adding the money received from the sale of assets, paying back loans or selling 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 cash provided for operating assets and liabilities. Using a free public template from the Small Business Administration (SBA), let’s say Wild Bill’s Dog Trainers and Walkers had a net income of $100,000 to start and generated additional cash inflows of $220,000.

As you can see in the spreadsheet, it spent $41,000 on operating cash outflows like hiring an additional person, buying new equipment for the dog park, paying taxes and more. The owner paid some principal down on a loan and took a draw of $50,000 for an ending cash balance of $127,200. Small changes in any of those line items show the impact of hiring more people, paying more taxes, buying more equipment and more to ensure the business has a healthy balance sheet and doesn’t go “into the red.”

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’s Toolkit

Five Steps to Cash Flow Analysis

There are a few major items to look out for trends and outliers that can tell you a lot about the health of the business.

  1. Aim for positive cash flow

    When operating income exceeds net income, it’s a strong indicator of a company’s ability to remain solvent and sustainably grow its operations.

  2. Be circumspect about positive cash flow

    On the other hand, positive investing cash flow and negative operating cash flow could signal problems. For example, it could indicate a company is selling off assets to pay its operating expenses, which is not always sustainable.

  3. Analyze your negative cash flow

    When it comes to investing cash flow analysis, negative cash flow isn’t necessarily a bad thing. It could mean the business is making investments in property and equipment to make more products. A positive operating cash flow and a negative investing cash flow could mean the company is making money and spending it to grow.

  4. Calculate your free cash flow

    What you have left after you pay for operating expenditures and capital expenditures is free cash flow. This can be used to pay down principal, interest, buy back stock or acquire another company.

  5. Operating cash flow margin builds trust

    The operating cash flow margin ratio measures cash from operating activities as a percentage of sales revenue in a given period. A positive margin demonstrates profitability, 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.