How to Perform a Cash-Flow Analysis

Cash is king when it comes to running a small business. Without money on-hand, you can’t make payroll, restock inventory or handle your bills. But business cycles are unpredictable and a cash crunch can even sneak up on highly profitable companies. A simple cash-flow statement analysis can help you from getting caught off guard.

By using this system, you can help better prepare for budget swings while also finding ways to free up more money from your operations. This article covers the answer to the question "What is cash-flow analysis?"—along with how you can get started.

Cash Basis vs. Accrual Basis Accounting

Before we cover the cash-flow analysis definition, you should figure out your overall accounting method. When you first set up your financial statements, you needed to pick a method for recognizing profits and losses: either cash or accrual basis.

Under the accrual basis system, you recognize transactions when they occur. The day your business makes a sale, you count the incoming revenue. Under cash basis, you only count a transaction once money changes hand. If it takes the client 14 days to pay their invoice on a sale, you don’t count the revenue until your business receives the money. The cash system is simpler to track and shows you when money comes in and out of your business; it has part of the cash flow-analysis already built in.

The accrual system can give you a more accurate view of your overall financial position, but it can lead to cash-flow surprises. For example, you’ve made a bunch of sales so you think you’re in good shape, but then it takes a long time for that money to actually come in. Whichever method you use, it’s still important to dive deeper into your actual cash-flow statement for the analysis.

Building a Cash-Flow Statement

The cash-flow statement summarizes the money coming in and out of your business. When your business receives cash, it’s an inflow and when you spend cash, it’s an outflow. You pick a period to track everything, like monthly or quarterly. At the end of the period, you add up all your cash inflows and subtract your outflows. If it’s a positive number, your cash position and bank balance should have grown. If it’s negative, you will have less cash.

To get a better idea what’s going on, you should break down the statement into three categories based on the type of activity: operations, investing and financing. 

Operations covers activities that come from actually running your business. For example, inflows from making sales and outflows from paying staff and buying inventory.

Investing covers transactions from long-term investments that aren’t related to the day-to-day operations of your business, like outflows from buying a new building or cash coming in from selling equipment you no longer need.

Financing covers transactions from loans and from investors in your company. For example, cash coming in from a new loan or going out because you’ve paid investors a dividend.

Glossary of Cash-Flow Metrics and Terms

As you browse through a cash-flow statement, these are some of the more important metrics and terms you might see:

Net income (loss): Your net income is your total profit each period after you add up all your sales and then subtract expenses, taxes and other losses. You see this figure at the top of a cash-flow statement. To find the actual change to your cash position, you’ll need to make several adjustments to your net income, covered below.

Depreciation/amortization: When you buy an asset like a building or equipment, it loses value over time. For physical assets, the loss in value is called depreciation and for non-physical assets like a patent, it’s called amortization. You count depreciation/amortization as a loss against your net income, but since it doesn’t cost you any actual cash, you add this amount back on your cash-flow statement.

Accounts receivable: If you made sales but your clients haven’t paid yet, the unpaid invoices count as accounts receivable. This goes as a negative for your cash-flow position because you haven’t received this income yet.

Accounts payable: On the other hand, if your business owes money to suppliers and other creditors, it’s called accounts payable. Since you still have the money for this debt, when your accounts payable position grows it increases your cash.

Inventory: To buy more inventory, your business needs to spend cash so when this figure increases on your cash-flow statement, it reduces your cash.

Finding ways to keep enough cash on-hand is essential for driving business growth.

Operating cash flow: This is the amount of cash left over after you’ve covered all your operating expenses during a period. If it’s positive, your business built more cash and if it’s negative, you spent down part of your cash reserves to cover everything.

Free cash flow: Free cash flow is what’s remaining after you’ve paid all your operational and investment expenses. It’s what’s left over for creditors and investors in your business.

Dividends: A dividend is a cash payment to the owners of your business to distribute their share of the profits. Dividends reduce your cash position.

Comprehensive free cash flow: If your business pays out a regular dividend to investors, you could subtract this from your free cash flow to get your comprehensive free cash flow. The idea is you’re trying to see how much cash is “free” after you handle all your business obligations.

Cash-Flow Analysis

With cash-flow analysis, you track your cash position each month to not only see whether it’s growing or shrinking, but also to see if there are any trends. For example, is your cash-flow balance growing steadily month after month or are there seasonable swings, like a big cash increase during your busy season followed by months of dwindling cash?

As part of the analysis, you try to figure out exactly why these changes are happening. That’s why you break down the transactions into the categories operational, investment and financial so you can find the root cause. For example, if your cash position grows, did that happen because you made more sales or because you took out a big loan?

By looking at your past results, you could also try forecasting your future cash position. Pick where you think your cash balance will be by the end of the next month or quarter. If the prediction is off, see what was different in the actual result versus your prediction. By getting better at this advanced cash-flow analysis, you’ll be able to proactively plan for cash swings rather than reacting only in the moment.

Driving Growth With Cash-Flow Analysis

Finding ways to keep enough cash on-hand is essential for driving business growth. After all, 52% of U.S. small-business owners have missed out on sales or projects worth at least $10,000 because of issues created by insignificant cash flow, according to the State of Small Business Cash Flow, a 2019 survey of 3,000 small-business owners in the U.S., U.K., Australia, Canada and India, conducted by Intuit QuickBooks with Wakefield Research. You don’t want that to happen to you.

First, you should look over your cash-flow statement for opportunities to do better. Let’s say your accounts receivables position keeps growing over time. Even though you’re making sales, customers are taking too long to pay so you aren’t getting the cash. Consider using a shorter payment deadline on future invoices or following up more frequently with customers who are late on payment.

By knowing the trends, you can also plan better for the future. If your cash position went up, is it from steady growth or a one-time influx? If it’s steady, it might be time to invest more in your business, but if your cash is about to shrink again, you should be more cautious.

Finally, if you can predict a cash-flow crunch before it happens, that’s an ideal time to set up outside financing like a line of credit. It’s easier to qualify when your earnings are still strong versus waiting until funds get tight.

By taking advantage of these cash-flow analysis strategies and paying more attention to your financial statements, you can help put your business in an even stronger position for growth.

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