Performing a cash flow analysis allows you to view your cash flow statement under a microscope to see the movement of money into and out of your business. A cash flow analysis shows whether your business is earning enough income to cover financial obligations and whether you have money left over after paying your bills. To perform a cash flow analysis, you will need your cash flow statement, which should include your business income and expenses on a monthly or annual basis.
Key points
Prepare a cash flow analysis
Examples of cash flow analysis
Interpretation of the statement of cash flows
Tips for cash flow managers in small businesses
Prepare a cash flow analysis: Step by step
To prepare a business cash flow analysis, follow these few steps that begin by gathering financial information about your business.
Step 1. Identify all sources of income.
The first step to understanding how money flows through your business is to identify the income that comes in regularly. When you create your cash flow statement in step three, you’ll need to calculate your net income. Your net income is the total amount of income for a period minus expenses, taxes and interest owed. So first you need to add up all the income your business generates over a period of time, including income from services provided or goods sold, but also money generated from investments or assets sold. For example, if you plan to analyze your cash flow for a specific month, quarter, or year, limit your total income to that time period.
Step 2. Identify all business expenses.
The second piece of information you will need to perform a cash flow analysis is your total business expenses. These may include purchases of inventory, accounts payable, deferred revenue for upcoming projects or services, or any other liabilities on your books. Other possible expenses include depreciation of fixed assets as well as income tax expenses. Similar to total income, you can keep your total business expenses limited to a specific point in time.
Step 3. Create a cash flow statement.
Once you’ve gathered information about your business’s income and expenses, you can organize the data into a cash flow statement. A cash flow statement typically has three sections that reflect operating income and expenses, company investments, and financial arrangements:
Operating Activities: This section presents funds related to your company’s main business activities. After subtracting expenses from income, you should ideally be left with a positive number in this section, indicating positive cash flow.
Investment activities: This section includes funds related to investing in assets, including the purchase or sale of long-term assets such as real estate and equipment, as well as stocks, bonds or other investments. Combining all investment activities in this section often results in a negative number – perhaps your company acquired a new building or vehicles this year.
Financing: This section includes newly borrowed funds and loan repayments along with the issue or buyback of company shares. Depending on the amount of debt and equity, the final number in this section may be positive or negative.
Step 4. Analyze your cash flow statement.
Now that you’ve done the hard work of plugging in the numbers—see sample worksheet below—it’s time to look for patterns. The closing document shows where your money is flowing over a given period of time. You can see how much of your funds are tied up in debt or investments, as well as how much money your business makes after operating expenses are taken into account. The sheet also allows you to compare the starting and ending cash amounts.
It would be ideal to see positive cash flow from your operating activities. However, it is also important to maintain investments and make strategic purchases to grow your business. Once you have a positive number on the first part of your cash flow statement, be sure to think about putting some of that surplus back into the business.
Examples of cash flow analysis
The details and format of the cash flow statement would likely vary from business to business. But every statement should contain the same general information – business income and expenses. There are several cash flow statement templates available for download online from sites such as Microsoft and SCORE, a business mentoring organization.
Here is an example of a cash flow analysis using the cash flow statement format described above. This example uses the indirect method, although it may be easier for your business to use the direct method. The difference between the two accounting methods lies in the level of detail you prefer in the operating activities section.
Remember that the information in your cash flow statement, and thus your cash flow statement analysis, would be tailored to your company’s individual circumstances. The fields in your statement may not be the same as the fields listed above, and you may need to add more or remove some. For example, if your business did not purchase an existing business, real estate, or intangible assets, you do not need to include these fields on the cash flow statement.
If you’d like to see real-world examples, you can find public company cash flow statements online. For example, you can look at Amazon’s annual report to see how a large company organizes its financial information.
Interpretation of the statement of cash flows
Interpreting your cash flow statement when performing a cash flow analysis shows how much cash your business has on hand after expenses are taken care of. Cash flow is not the same as profit, which is sales revenue minus expenses. Instead, a cash flow analysis examines your income and expenses on a monthly, quarterly, or annual basis.
Time your spending better
Keeping track of when your business receives money can help you better budget for regular expenses like payroll and insurance bills. You will also be able to determine what kinds of business purchases you can afford.
Look at the negative balance at the end of any given month and examine the timing of cash flow in and out throughout the month to see where you may be overestimating your cash flow. As we have already mentioned, a negative balance can be normal in the part related to investment activities.
Look for patterns of deficits
For example, if you notice a deficit in the same month every year and it gets bigger over time, you may have a major sales problem. Sometimes a deficit occurs during months when a large payment, such as insurance or quarterly taxes, is due. However, if this negative number increases over time, you may need to adjust your business model.
Tips for managing small business cash flow
Once you’ve completed a cash flow analysis, you’ll be armed with information that will help you improve cash flow in your business.#
1. Plan your upcoming expenses.
Now that you know when money moves in and out of the business, set aside funds for upcoming expenses or when you anticipate financial distress. If you know your business is about to slow down, you can take steps early to ensure your cash flow remains consistent and you can continue to meet your obligations. A business line of credit with no maintenance or annual fee could be one way to ensure you have access to quick financing or want to take advantage of a one-time opportunity.
2. Increase your income.
An increase in sales would increase your operating income as well as charging for your products and services. You may want to consider putting the excess cash into hiring more employees to increase production or expanding the business to another location. If you decide to raise prices, be careful not to push customers away. A drop in customers could cause losses that would hurt your overall cash flow.
3. Recheck your payment plans.
Spreading payments to vendors can help you retain more cash over a period of time. For example, you may be able to negotiate a 90-day payment plan with the seller to delay the due date of your bill. At the same time, you can encourage your customers to pay you at a faster rate. Consider incentives to encourage early payment, such as discounts on invoices that are paid before the due date. Maximizing the time between receiving payments from customers and paying your vendors would allow you to hold on to cash for as long as possible.
