How to do a cash flow analysis

A cash flow analysis is the process of analyzing your company’s income sources and expenses to figure out if it has enough funds to operate. It’s commonly used to analyze a business’s working capital, the money it can use for day-to-day expenses. The more positive cash flow your business has, the more easily it can handle operating expenses, debt payments and other bills. Negative cash flow means that you’re likely pulling funds from savings to cover expenses.

Let’s dive into why and how you should perform a cash flow analysis regularly to assess your business’s finances.

Why is cash flow analysis important?

A cash flow analysis is important to give you a picture of your company’s finances all in one place. The analysis will help you determine if you have the capital needed to run the business as well as make new investments. You can also see whether business loan payments will fit in your budget if you plan on applying for a business loan.

According to the 2023 Small Business Credit Survey, 77 percent of employer-based businesses faced the challenge of rising supply costs, and 52 percent struggled to pay operating expenses. In response to these challenges, 40 percent obtained funds that must be repaid. A cash flow analysis can help businesses decide whether to get a small business loan.

How to prepare a cash flow analysis

To prepare a cash flow analysis, follow these steps.

1. Create a starting balance

The first thing to do is figure out what accounting period you’ll look at. It’s common to perform cash flow analysis on a monthly, quarterly, semiannual or annual basis.

Once you’ve chosen the period you’ll be looking at, find your company’s cash balance at the start of the period.

2. Identify cash coming in

Once you’ve found your company’s starting cash balance, you’ll look for sources of incoming cash during that period. Find the total income from all sources, such as:

• Income from sales of goods or services
• Interest income
• Cash received from the sale of property or investments
• All other income

You’ll need to look through your company’s records to identify all the income sources. Check every document, including balance sheets, profit-and-loss statements and other records to identify every transaction.

3. Identify cash going out

Next, you’ll look at all your cash outflows during your analysis period. Tally up the money spent on things like:

• Wages paid
• Sales and marketing
• Inventory purchased
• Deferred revenue
• Depreciation
• Income tax
• Anything else that you spent money on

4. Create a cash flow statement

Once you’ve found all of the sources of income and expenses in your business, you’ll need to categorize them. Cash flow analyses typically group income and expenses into three categories:

• Operating activities. These are core business activities. If you run a store, this could include revenue from sales and expenses like wages and inventory. Sale of real estate or interest income wouldn’t count. Ideally, you’ll have a positive number here.
• Investing activities. This is where you account for any income and expenses related to long-term investments such as asset purchases, purchase or sale of stocks, bonds or other securities, and other investments. Negative numbers are common here because you expect to benefit from investments, like new machinery or technology, for many years and to use it to improve operating cash flow.
• Financing activities. This covers any money received from loans and money paid back to lenders; it can also include business credit card use if you carry a balance. It’s also where companies note things like stock issues or buybacks. Negative numbers are usually good here because they indicate the repayment of debt or payments to shareholders.

What to look for in cash flow analyses

Once you’ve prepared your cash flow statement, it’s time to analyze it to understand your business’s finances.

Start by looking at your overall cash flow. Is it positive or negative? In general, positive numbers are good, while negative numbers can be a bad sign. But short-term negative cash flows, especially those caused by purchasing key investments, such as real estate or equipment, aren’t necessarily bad.

A common item people look for is free cash flow. This is a measure of how much cash your business generates after accounting for operating costs and maintaining key assets.

Keep in mind that the cash flow statement for companies in different stages of their lifecycle will look quite different. Startups will almost certainly have highly negative cash flows, relying on investments and savings to grow. Established blue chips should have highly positive operating cash flows and likely have neutral investment cash flows.

Cash Flow Analysis Example

In this example, notice how the company lists each income and expense to find the total that increased or decreased over the month. Since the total cash on hand decreased, this company may decide how to boost sales or reduce debt so that it can have positive income in future months.

Bottom line

Cash flow analysis can be incredibly helpful if you want to get a sense of how your business is doing and whether you’re operating with positive cash flow. It can also be helpful for understanding your company’s ability to afford new business loans or major investments.

It’s important to consider all types of income and expenses and to detail each source in the cash flow statement. Those include your operating, investing and financing activities that your business is involved in. You’ll then be able to see your financial picture in one place, helping you make decisions about how to propel your business forward.

Frequently asked questions

• What can cash flow tell you?

  A cash flow analysis can tell you if your business is operating at a profit or at a loss. It shows you whether your business gained or lost income over all the sources of income and expenses that it has. These details will help you decide your next steps for growing your business, including whether you need business financing or whether you should make some other business investment.

• What are the 3 types of cash flows?

  The three types of cash flows are:

  • Operating cash flow. Those related to the company’s core operations.
  • Investing cash flows. Those related to buying or selling long-term investments and property.
  • Financing cash flows. Those related to loans and share issues/buybacks.

• Is cash flow the same as profit?

  No, cash flow and profit are different. A company can have positive cash flow through borrowing money or selling assets, even if its profit is negative.