Chad Morris
By: chadmorris
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Cash Flow Analysis Tips and Tricks

Every small business should know how to perform a cash flow analysis. Why? Simply put, because, in business, cash is king. You need money on hand to pay employees and creditors, and to ensure your daily operations run smoothly. In a few words, by doing a proper cash flow analysis, your business is more likely to survive whatever challenges lie ahead.

What Is Cash Flow Analysis?   

While the balance sheet and income statement are better known in the business world, the cash flow statement is just as important. Cash flow analysis is simply a study of that statement. 

To keep your business profitable, you need to see where the money is coming from and where it’s going. Cash flow analysis gives you a monthly picture of this in-and-out flow of money. It helps you to measure liquidity, which is an indication of how promptly you can pay your bills. It can also tell you if you need a little assistance from a business loan and how much that loan should be. If there’s not enough money coming into your business, cash flow analysis can also pinpoint areas where you can cut costs. 

Are you ready to get started? Great. There are three primary phases of cash flow analysis: first, you have to create your cash flow statement. Then, you need to review it properly. Last but not least, you need to know what to do with the new information you gathered.

Cash Flow Analysis Phase 1: Create a Cash Flow Statement

The first thing you need to do is to write the cash flow statement. The document can be broken down into 3 areas of business activity.

The 3 Sections of a Cash Flow Statement

  1. Operating Cash Flow: These flows include expenses (taxes, salaries, rents, etc.) and revenue from sales. Because this is a cash flow statement, the revenue must be in the form of money, and not in the form of credit. 
  2. Investing Cash Flow: If you acquire cash from the sale of equipment, use cash to make an investment in other companies or the stock market, or purchase real estate to expand, those flows should be shown under “investing operations”.
  3. Financing Cash Flow: If you finance your business using loans, the addition of cash needs to be recorded as money coming in, and the money spent on interest must be entered in the opposite direction. 

The 2 Methods of a Cash Flow Statement

There are 2 basic ways a cash flow statement can be prepared. The first is with the indirect method. This system uses accrual accounting, which records revenue when it’s earned instead of actually received from the customer. With the indirect method, you start with net income and then adjust it by adding back some non-cash items like amortization and depreciation. 

The direct method is a little simpler. It counts the cash received by a business and the amount that goes out. The difference between both methods lies in the way the operating cash flow (OCF) is calculated. Hopefully, this amount is positive. 

Let’s take a look at an example from a hypothetical auto parts store:

Activity                                 Cash flow

Sales                                           $70,000

Rent                                            ($10,000)

Salaries                                       ($25,000)

Inventory                                    ($15,000)

Taxes Paid                                   ($5,000)

Cash from Operations           $15,000


With the indirect method, we arrive at the same bottom line, just in a different way:


Net Income                               ($60,000)

Depreciation                              $20,000

Loss on sale of equipment        $15,000

Amortization                               $30,000

Taxes Paid                                    $10,000

Cash from Operations           $15,000

Cash Flow Analysis Phase 2: Review and Analyze Your Cash Flow Statement

Now that you understand the basic building blocks of a cash flow statement, it’s time to do some actual cash flow analysis. There are several key areas you want to be sure to scrutinize. 

4 Areas to Review in your Cash Flow Statement

1. Free Cash Flow

The formula for calculating free cash flow is quite simple. It is:

Free cash flow = Operating cash flow – Capital expenditures

The operating cash flow is taken from operating activities, one of the three categories discussed above. It is also known as Cash From Operations (CFO). To calculate this first variable, use the following equation:

CFO = Net income – Increase in working capital + Non-cash expenses

Once you have the CFO, simply subtract capital expenditures. They are oftentimes referred to as CapEx. 

Scrutinizing operations in this way is important. Lenders often use free cash flow to analyze how easily a business can pay its bills. You should use it, too.

2. Revenue Not Yet Received from Customers

Sometimes a sale might be completed, but payment hasn’t been received yet. Focusing on uncollected debt can reveal sources of potential future cash flows. A large number of late payments could be a sign that a small business needs to improve on collecting unpaid invoices

3. Change in Inventory

Be sure to examine the line that says “change in inventory” on your cash flow statement. If you bought more inventory than you disposed of, the number will be negative. If the number is positive but lower than you were anticipating, it could be a sign that you purchased more inventory to sustain a healthy business. 

4. Cash Flow to Sales Ratio

Generating cash flow is not enough. You must be able to produce cash flow in proportion to your sales. As revenue increases, cash flow should increase as well.

To evaluate this area of your small business, use this equation:

Cash flow to sales ratio = Operating cash flow / Net sales 

Net sales are gross revenue minus the cost of discounts, sales returns, and allowances. If the ratio declines as revenue increases, it could be a sign that customers have lengthy payment terms. This leaves money in accounts receivable too long. 

Cash Flow Analysis Phase 3: What to Do with the New Information?

Once you have the tools, you’ll be ready to actually use cash flow analysis to improve your operations. Here are a few things you can do:

Cash Flow Forecasting

When you learn to perform cash flow analysis, you’ll be able to predict cash flow in future months, an essential task when it comes to managing a small business. Projections can be weekly, monthly, quarterly, or annual forecasts. When you develop accurate predictions, you’ll know how much of a loan to acquire or how much money can be spent on the acquisition of a new piece of equipment. 

Fixing Problems that You Identify

During your cash flow analysis, you’ll certainly find areas where your business isn’t doing as well as it needs to. For example, you might see that overhead expenses (things like utility bills, rent, salaries, etc.) are higher than you were expecting. If this is the case, you’ll see your cash flow reduced. When you identify an area where your small business is spending too much, you can develop strategies to reduce spending in that part of the business.

Compare Profit to Cash Flow

Once you discover how your small business is doing in the area of cash flow, you can compare profits to cash flow performance. It’s possible to do well on the cash flow statement while underperforming in the profit category, or vice versa. There’s a tendency in the business world to focus too much on profits. In order to succeed over the long term, profits and cash flow of a small business must be mutually beneficial. 

Analyze Profit Margins

Once you become adept at cash flow analysis, you’ll be better able to look at your business’s profit margins and see if you’re generating enough revenue relative to expenses. Different industries will have different standards, although a net profit margin of around 10% is generally considered good. 

Getting the Help You Need

If your cash flow needs a boost, a loan from Camino Financial can help you get your business where it needs to be. Funds from our business loan can be used for a variety of purposes: your daily operations, your plans for expansion, or simply to improve your cash low levels. It takes just a few minutes to complete our online application to find out instantly if you qualify. After approval, it takes less than a week to secure your funds. Our motto is “No business left behind.” That includes yours!

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