Cash Flow Analysis Techniques and Tips

Last Updated September 13, 2023

Running a small business is no easy feat, but running a successful small business takes even more time and skill.

Performing a cash flow analysis and looking at your expenses can be the difference between your business floating or sinking. Knowing the financial health of your company helps you identify what you’re doing right and what you need to improve. Do you have issues with your cash conversion cycle? Maybe your business operates on COD payment terms, and your unpaid invoices are holding you back. All of these, and more, are important questions to ask when considering your cash flow situation.

Here’s a quick guide to help you conduct your own cash flow analysis, an important component of cash flow management.

What is a Cash Flow Analysis?

While you may be familiar with other business spreadsheets that help you stay on top of your profits, the cash flow analysis is just as critical.

Each month, you need to know how much is flowing into your business and leaving based on expenses. This is what a cash flow analysis is good for — tracking the money as it flows in and out of your business.

Cash flow analysis can show you how your business is succeeding and growing, but also the ways it’s lacking. This analysis shows you the big picture of your company’s financial health. You’ll see what business tactics are working and which ones aren’t. From there, you can make necessary changes to where your money is allocated.

It’s important to remember you don’t have to just do cash flow analyses, or cash flow budgets, every month. You can keep track of multiple different cash budgets so you see how your business is doing on a quarterly or even yearly basis. Also keep in mind that a cash budget is different from a statement of cash flows.

How to Calculate Cash Flow Analysis

Once you get the hang of it, calculating your small business’s cash flow is as easy as it is necessary. There are a few different steps to follow to create a correct cash flow analysis.

Create a Cash Flow Statement

A cash flow statement is about more than seeing how much is going in or out of your company. It specifically details where the income is being spent, so you can see how much you’re spending on operations, investing, and financing.

This method may sound similar to income statements and balance sheets, but a cash flow statement is much different.

Balance sheets and income statements do help track money movement, but it’s based on accrual accounting and not cash. Cash flow statements specifically keep track of cash movements, taking away the non-cash factors that sometimes make a business look better on paper.

It’s great if your business looks great on paper, but it needs the cash trail to match. Cash flow statements help you track your company’s liquidity, your company’s cash sources, the cash flow that goes towards assets or operations, and whether your company’s overall cash level has increased or decreased.

Analyze Your Cash Flow Statement

Your cash flow statement will have three different categories: operations, investments, and finances. Looking at each one will help you understand how much you’re spending and give a better picture to potential investors.

Operations

On a base level, you need to know how much it costs to keep your small business operating smoothly and efficiently. Hopefully, your sales cover more than this baseline, but at a bare minimum, you should be making enough to pay your bills and keeping a positive cash conversion cycle.

A cash flow analysis will help you see not only how much your bills cost, but how easily you’re paying them.

Investments

This section covers what part of your cash flow is going into other business ventures. Investing in a bigger retail space or even in the stock market can be a smart move, but you need the cash to back it up.

A closer look at this section will help you identify if you’re investing more than you’re making.

Finances

This section specifically focuses on if you’re financing your business with loans. When money comes in, you count it as a positive addition to the business’s finances. But the money spent on interest and paying back the loans is, of course, entered as a deficit.

Calculate Your Free Cash Flow

There are three different ways to calculate your free cash flow. Each method should yield the same number, but these different formulas were created because not every business is the same or logs the same numbers.

Operating cash flow is the simplest way to calculate your free cash flow. This formula uses information from your business’s cash flow statement and balance sheet:

Operating Cash Flow – Capital Expenditures = Free Cash Flow

You can also use your sales revenue or your net operating profits to calculate your free cash flow. However, these methods are more complicated and require more in-depth mathematical formulas.

Calculate Your Cash Flow Ratio

This cash ratio compares your sales revenue to your operating cash flow. You need to make sure that your cash flow is increasing as much as your sales. The following equation will help you calculate your ratio:

Operating Cash Flow / Net Sales = Cash Flow Ratio

In this case, your net sales are your business’ gross revenue where all discounts, returns, and allowances have been deducted. If the ratio decreases as your revenue increases, that’s a bad sign for your business and needs to be remedied immediately.

What To Do With Your Cash Flow Analysis

After you’ve conducted your cash flow analysis, you’re going to have a ton of new information.

Now is the time to sort through it and make sure you’re making changes to how your business is operating. You’ve done all these calculations for a reason — now it’s time to put it to use.

Predict Your Future Cash Flow

These formulas have now helped you predict what your cash flow will be in the coming months. With this in mind, you know your future budget and how much of a loan you may need to take out if necessary.

Depending on how you’ve calculated, you have a better picture for the coming weeks, months, quarters, or even the upcoming year.

This process is an essential part of cash flow risk management and cash flow modeling.

Fix the Problems You’ve Found

If this is your first time conducting a cash flow analysis, there will be areas you need to fix. After looking at the hard numbers, you may find you’re paying more for something than you were anticipating.

It’s possible you identify issues with customer payment and outstanding invoices. If that’s the case for your business, you may be a fit for alternative cash flow financing, like invoice factoring or accounts receivable financing. These can be useful tools to boost working capital without damaging your credit.

Now, you can fix it and reduce spending in areas you know you can change and save money on.