Cash Flow Analysis Techniques and Tips

Understanding Cash Flow Is Key to Business Success

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Two of the financial statements that businesses prepare as part of their monthly accounting cycle are the income statement and statement of cash flows. The income statement shows a firm's profit or net income, while the statement of cash flows shows the firm's cash position. You'll need to understand cash flow if you're operating a small business.

Key Takeaways

  • Negative cash flow isn't always bad. For example, it could be due to investments you have made to grow your company.
  • Free cash flow is what your business has available after paying for capital expenditures
  • You can use cash flow ratios to calculate your business's liquidity, solvency, and viability

Cash Flow

A company's cash flow at any point in time is the difference between its cash available at the beginning of an accounting period and at the end. The cash includes loan proceeds, investment income, and the sale of assets, and goes out to pay for operating expenses, direct expenses, principal debt service, and the purchase of assets such as equipment. When you operate a small business, cash is king. You can be profitable on paper, but cash poor.

How to Do a Cash Flow Analysis

Cash is the gasoline that makes your business run. A cash flow analysis is a method for checking up on your firm’s financial health. To do a cash flow analysis, you'll first need to prepare your operating, investing and financing cash flow statements. 

You generally want to see positive cash flow. However, there are situations in which negative cash flow isn't a bad thing. For example, if your business is making investments and growing, there may be a negative investment cash flow.

You should calculate your free cash flow (FCF), which is what is left after you pay for your operating expenditures and capital expenditures.

You'll also want to look to see if the operating cash flow margin is positive. The operating cash flow margin can show you how much cash there is from operating activities as a percentage of sales revenue.

The Difference Between a Cash Budget and a Statement of Cash Flows

Keeping track of cash flow is essential for the survival of your small business. However, accountants sometimes speak about the cash budget and a more comprehensive statement of cash flows.

Cash Budget

A cash budget is used to estimate your business's cash inflows and outflows over a specific period of time. They can be used for both long-term and short-term goals. Cash budgets are designed to predict future cash balances and identify potential cash deficits and surpluses. You can then use those predictions to create plans to manage those situations.

To make a cash budget, you'll need to take an itemized list of all sources and uses of cash in a given time period. Then, using the current cash balance, you can create a plan that addresses how to manage the net cash position of a given time period.

Statement of Cash Flows

The statement of cash flows is used to show how money moved in and out of the business. This statement has three sections:

  • Operating activities: Earning money, paying expenses, and funding working capital
  • Investment activities: Gains and losses from buying and selling assets and investments
  • Financing activities: Any cash flow activities that change the size and composition of contributed equity and borrowings

The First Step in Analyzing a Statement of Cash Flows

A business owner must look at the last two years of the firm's balance sheets and compare the differences between the two in order to develop ​the statement ​of cash flows.

With information from an income statement, such as profit or loss and depreciation, as well as the information from the comparative balance sheets, particularly how current assets and liabilities may have changed, you can develop your statement of cash flows.

Analyzing a Statement of Cash Flows

Analyzing a statement of cash flows involves looking at the sources and uses of funds from the comparative balance sheets, which allows a company to better see its future cash needs.

Calculate Your Company's Free Cash Flow

The free cash flow calculation is one of the most important results that a small business owner can take away from the analysis of the statement of cash flows.

Simply put, free cash flow is the cash that a company has left after it pays for any capital expenditures it makes, like a new plant or equipment.

Free Cash Flow Calculations

Free cash flow is how much money your business has left over to use for other purposes after it has paid for capital expenditures, including buildings and equipment, and other expenses needed to sustain its ongoing operation.

The equation to calculate free cash flow is:

Free Cash Flow = Operating Cash Flow (CFO) – Capital Expenditures

Calculate Cash Flow Ratios for Your Company

Several financial ratios—including operating cash flow, price/cash flow, and cash flow margin—help business owners focus on cash flow.

Calculating these cash flow ratios for your company can give you information about your business's liquidity, solvency, and viability. Add these calculations to your cash flow analysis to strengthen it.

Frequently Asked Questions

What are the 3 types of cash flows?

The three types of cash flow come from a business's operating activities, investing activities, and financing activities.

What is a good measure of cash flow?

Free cash flow is a very useful measure of cash flow for a business. It's the measure of the cash that a business has available after capital expenditures like inventory or real estate are paid for. Free cash flow shows you how much money your business has to expand and grow.

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  2. Datarails. "Cash Budget."

  3. Corporate Finance Institute. "Statement of Cash Flows."

  4. Seeking Alpha. "Free Cash Flow."

  5. Corporate Finance Institute. "Free Cash Flow (FCF)."

  6. NetSuite. "Cash Flow Analysis: Basics, Benefits and How to Do It."

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