How To Do Cash Flow Analysis For Your Business

Cash flow is one of the most important aspects of running a successful business. But how do you calculate your cash flow? Once calculated, what can this information tell you about your business?

There are several different ways of calculating cash flow, and it can be hard to know which way is best. In this post, we’ll teach you the most common way to calculate cash flow: running a cash flow statement. We’ll also teach you what a healthy cash flow statement should look like and how to analyze your cash flow using the free cash flow ratio and a cash flow forecast. With these three cash flow calculations in tow, you’ll understand your business’s cash flow in no time.

What Is Cash Flow?

Cash flow is the money that comes in and out of your business. When a customer pays you for a product or service, cash is “flowing” into your business. When you have to purchase supplies, inventory, pay bills, or cover an emergency, cash flows out of your business.

When calculating cash flow, it’s easy to assume that you simply subtract the cash outflows from the cash inflows. This is the process, in theory, but the application of that theory is much more complicated. In reality, using a cash flow statement can simplify the process.

How To Calculate Cash Flow With A Cash Flow Statement

A cash flow statement, or statement of cash flows, is a report that measures the cash coming in and out of your business during a specific period of time. The cash flow statement shows four different cash flow figures:

• Operating cash flow
• Cash flow of investment activities
• Cash flow of financial activities
• Net cash flow

To calculate your cash flow, use the following formula:

Operating Cash Flow +/- Cash Flow Of Investment Activities +/- Cash Flow Of Financial Activities = Net Cash Flow

Fortunately, accounting software can simplify the process, ensuring that your figures are accurate and doing the math for you.

Creating A Cash Flow Statement

Along with the income statement and balance sheet, the statement of cash flows is one of the most important financial statements in accounting.

You can create a cash flow statement by using Excel or Google Sheets, but the easiest way to generate a statement of cash flows is by using accounting software. Most accounting software will do all of the hard work for you. Simply make sure your income and expenses are up-to-date, tell the software to crunch the numbers, and voila! You have yourself a cash flow statement.

You’ll see that the cash flow statement is divided into three sections: cash flow of operation activities, cash flow of investment activities, and cash flow of financial activities. We’ll walk you through each section so you can understand exactly how the cash flow statement works and what it’s telling you about your business.

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Cash Flow Of Operation Activities

Cash flow of operations, or operating cash flow, shows the total cash gained or spent on business operations during a given period. Operating cash flow is used as a key indicator of how efficient and healthy your business is. It is one of the most common (and important) cash flow calculations.

Here are some examples of the operating cash inflows and outflows you can expect to see on your statement of cash flows:

• Inventory purchases
• Wages
• Cash received from sales or services
• Interest earned
• Rent payments
• Other operating expenses

Your total operating cash flow is calculated by subtracting the cash outflows directly related to your business operations from the cash inflows directly gained from your business operations.

When you run a statement of cash flows, you’ll see your total operating cash flow expressed under “net cash flow for operating activities.” This amount shows what you made (or lost) on basic business operations. You can use the cash flow of operating activities to:

• See how much cash you’ve gained from your business operations in a given period
• Understand which business expenses you’re spending cash on
• Analyze where to cut back on operating business expenses

Cash Flow of Investment Activities

The cash flow of investment activities shows how much cash you spent on long-term investments and made on long-term investments.

For most businesses, this section of the cash flow statement shows cash spent on purchasing new fixed assets and cash gained from selling fixed assets. (Fixed assets are valuable items owned by your business that have a long-term use.)

Examples of investments that you may see on the cash flow of investment activities section of the cash flow statement include:

• Purchasing or selling property
• Purchasing or selling buildings
• Purchasing or selling equipment
• Purchasing or selling company vehicles
• Capital expenditures (CapEx)

Basically, cash flow of investment is affected by any change to your long-term assets — or property, plant, or equipment (PPE) — and any expenses paid to manage current assets (which is referred to as capital expenditures). Your total cash flow of investment activities is calculated by subtracting your investment cash outflows from your investment cash inflows.

You can use the cash flow of investment activities to analyze the state of your company’s fixed assets. Lenders and potential investors also use this cash flow ratio to see if your company is growing.

Cash Flow Of Financial Activities

The cash flow of financial activities shows the cash spent and received from financing — or raising capital. Cash flow of financial activities is used to see how much cash you’ve received from loans or investors and how much cash you’ve spent on paying back debts and shareholders.

Here are some examples of the financing cash inflows and outflows you can expect to see in the cash flow of financing activities on your statement of cash flows:

• Cash received from loans
• Loan payments
• Cash received from investors
• Dividends paid to shareholders
• Purchasing company stock

Your total cash flow of financing activities is calculated by subtracting the financing cash outflows directly related to financing (like paying past debt and shareholders) from the cash inflows raised from financing (like new loans and cash from investors).

The cash flow of financial activities is important for analyzing whether your business has the cash to pay off its debt or to take on new debt. This is a key cash flow formula for potential lenders and investors as well. Lenders want to see that your business has the means to make payments on a new loan, and potential investors want to see that your company has the cash to pay back shareholders.

What Does A Good Cash Flow Statement Look Like?

So now that you know what a cash flow statement is and how to run one, how do you know what your cash flow statement means? What does your cash flow statement say about your business’s financial health? What is good cash flow and when should you be worried about your cash flow?

Don’t worry, your cash flow statement has answers to all of these questions. We already briefly mentioned how each type of cash flow can be used to analyze the health of your business. In this section, we’ll recap each section of the cash flow statement and give you a clearer idea of what a successful business’s cash flow looks like.

1. Good Net Cash Flow

Your net cash flow appears at the bottom of your statement of cash flows and is a total of your cash flow of operating activities, your cash flow of investment activities, and your cash flow of financial activities. This total will either appear as a net increase in cash flow or a net decrease in cash flow. Ideally, you want a net increase in cash flow, which shows that your company brought in more money than it spent.

While you want a positive cash flow, you may not want your cash flow to be too positive. Seem counterintuitive? Here’s why.

If you have an incredibly high cash flow, that is extra money that you can be (and should be) investing back into your business. It’s important to strike the balance of maintaining a positive cash flow and using that positive cash flow to ensure that your business grows and makes even more money in the future.

2. Good Operating Cash Flow

Your operating cash flow shows how much money your company is making or losing on everyday business operations. Business operations are the bread and butter of your business, so it makes sense that you want your operating cash flow to be a high, positive number. You always want to see this number increasing over time.

If your operations appear as a net loss instead of a net increase, you may want to reevaluate your business practices. Increase prices, don’t reorder unpopular inventory, streamline processes to save time and money on payroll, incentivize customers to pay their invoices in a timely manner — do whatever it takes to spend less and bring in more so that your business can flourish.

That being said, it’s important to not only know what your operating cash flow is but to analyze why your operating cash flow is negative or positive. There may be some months that you have a negative operating cash flow, and that may not be a bad thing.

Let’s say you run a seasonal business and you spend a large sum on purchasing inventory to prepare for the holiday season. Because of this, your September cash flow statement shows a net loss on operating cash flow. However, during October, November, and December, you bring in tons of cash selling the inventory you purchased. You wouldn’t have been able to make strong sales or have such a positive cash flow during the holidays without that extra inventory.

In this case, one month of negative cash flow led to three months of incredibly positive cash flow, which was more than worth it. You only have to start worrying if your operating cash flow is negative again and again.

3. Good Cash Flow Of Investing Activities

Your cash flow of investing activities shows how much money you’ve spent on purchasing and maintaining fixed assets or on selling assets.

Typically, most growing businesses will have a net loss on cash flow of investing activities. While that may sound ominous, it really means that you are actively investing in new fixed assets to expand your business and replacing old equipment to help your business run more efficiently. This is a good thing.

4. Good Cash Flow Of Financing Activities

Your cash flow of financing activities shows the cash used to pay off your business’s existing debts and any new financing or loans received.

Generally, you want to see a negative net cash flow from financing activities. This means that you are paying off existing debt and paying dividends to shareholders.

That being said, it is okay to have a net gain in cash flow of financing activities at times. A positive net cash flow of financial activities means your business has gained cash from investors or secured a new business loan. While some business owners may assume that debt is always a bad thing, there are several good reasons for applying for a business loan:

• To purchase new equipment that will benefit your business
• To expand your business
• Purchasing inventory
• Hiring and training employees

If you can afford to take on a loan, the extra funds may be just what your business needs to succeed. Use the cash flow of financing activities to analyze your business’s financial state and determine what is healthiest for your future.

How To Use The Free Cash Flow Ratio

The free cash flow ratio is one of the most important ratios a business owner should know. While the cash flow statement shows your overall net cash flow, the free cash flow ratio shows the amount of cash that is actually available for your business to use. This ratio is incredibly important for analyzing your business’s financial health.

Free cash flow shows you the amount of the cash left over after paying for your business’s operating expenses (the expenses required to run your business) and capital expenditures (the expenses spent on purchasing and maintaining your fixed assets). You can calculate your free cash flow by using this formula:

Free Cash Flow = Operating Cash Flow – Capital Expenditures

Simply take the net operating cash flow from your cash flow statement and subtract the total capital expenditures for your business.

By using this formula, you can see exactly how much free cash flow your company has to work with. Free cash flow is particularly important when considering taking on a new working capital loan to expand your business. Knowing exactly how much money you have in free cash, on average, can help you determine the loan payments you can afford.

How To Create A Cash Flow Forecast

Another important step in analyzing your business’s cash flow — and, in turn, your business’s health — is to create a cash flow forecast.

A cash flow forecast, also known as a cash flow projection, is an estimation of your future cash inflows and cash outflows over a specific period of time (usually a year). This estimation should be based on past cash flow data or educated guesses on the cash sales and expenses you expect to face in the upcoming year. This helps your cash flow projection to be as accurate as possible.

While cash flow forecasts are beneficial for any business wanting to get a handle on its finances, they are particularly helpful for seasonal businesses. A cash flow forecast can help you pinpoint the months during which cash will be tight and the months during which cash will be plentiful. This way, you can plan to save enough cash to cover expenses during the slow months.

In this way, a cash flow forecast gives you valuable business insight. Additionally, comparing your cash flow projection with your cash flow actuals at the end of the year is an important business practice for seeing if you met your business goals, where your company is excelling, and where it could still improve.

Many accounting software programs have a cash flow forecast report built-in. However, if your accounting software doesn’t have a cash flow projection, you can create one manually by estimating your:

• Cash sales for each month
• Expenses for each month
• Fixed asset investments
• Debt payments
• Additional capital

Be as realistic as you can and include any sales or expenses that directly affect your business’s cash. If you don’t want to calculate this all by hand, there are several free cash flow forecast templates available online as well.

Analyzing Business Cash Flow FAQs

Next Steps After Cash Flow Analysis

As a business owner, it’s important to track your cash flow to determine the next steps your business needs to take. This could be applying for a small business loan to improve cash flow, using extra funds to invest back into your business, or cutting unnecessary expenses that hinder your cash flow. There’s truly no better way to do this than with cash flow analysis.

Now that you know how to run a cash flow statement, use the free cash flow ratio, and create a cash flow statement, you can confidently understand your company’s cash flow. You can use all three tools to analyze your business’s cash flow. These tools will let you determine where your business is excelling and where it could be improved, help you figure out if you can afford a loan, and prepare for the lean cash flow months.

After analyzing your business’s finances, you may determine that you need a working capital loan or a line of credit to help you maintain positive cash flow. Read through our detailed small business loan reviews or view our business loan comparison chart to find a lender that works for you.

If your business depends on invoices, invoice financing might be more your speed. With invoice financing, it’s possible to get cash for your invoices right away.

For more information on accounting concepts and strategies, our accounting and bookkeeping blog is a good place to start. We cover everything from double-entry accounting to small business taxes. We also guide you through how to choose small business accounting software. What’s more, our comprehensive accounting software reviews cover QuickBooks products, Xero, Freshbooks, Sage, and more of the top cloud-based and locally-installed accounting solutions on the market today. For a bird’s eye view of the top contenders, check out our accounting software comparison chart.