How to Prepare a Cash Flow Analysis

By

Janet Berry-Johnson, CPA

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Reviewed by

on

September 29, 2022

This article is Tax Professional approved

Group

Many small business owners equate business success with profits. Profits are important, but there’s a reason people say, "Cash is king."

It’s entirely possible for your business to be profitable, yet still have trouble getting a loan, attracting investors, or keeping the lights on because you’ve neglected cash flow.

That’s where a cash flow analysis comes in handy. By following our step-by-step guide, you can feel confident knowing your cash situation and make better decisions about where to spend and where to make cuts.

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What is a cash flow analysis?

A cash flow analysis tracks cash flow in three areas:

  • Cash flow from operating activities
  • Cash flow from investing activities
  • Cash flow from financing activities

If you’ve ever looked at your business’s financial statements, you may notice that these are the same categories that appear on a cash flow statement.

When you perform a cash flow analysis, you see where your money comes from and where it’s going, providing crucial information about your business finances.

How to do a cash flow analysis

Here’s a step-by-step guide to preparing your own cash flow analysis.

Step 1: Gather your financial information

You’ll need information on your business’s beginning and ending cash balances, balance sheet accounts, and net income. You can find all this information in your company’s balance sheet and income statement.

Helpful resources: Free Income Statement Template and Free Balance Sheet Template

Step 2: Create your cash flow statement

Once you have your financial information in hand, you can organize the data into a statement of cash flows.

A cash flow statement includes three main sections:

  • Cash flow from operations. This section contains sources and uses of cash related to your core business operations. You start with net income, then adjust for anything that impacts net income but doesn’t affect cash. Examples include depreciation and amortization expense and accrual accounting changes to your accounts receivable, prepaid expenses, accounts payable, and accrued liabilities.
  • Cash flow from investing activities. This section includes sources and uses of cash related to investing in fixed assets and the sale of assets and other investments, such as available-for-sale securities. An example of cash inflows would be paying cash for a new piece of equipment. An example of cash outflows would be selling marketable securities for cash.
  • Cash flow from financing activities. This section includes sources and uses of cash related to financing business operations via debt and equity. For example, if you take out a loan, the proceeds from that loan would increase cash. On the other hand, paying cash dividends to shareholders would decrease cash.

Your statement should start with your beginning cash balance and add the net cash flow from the three sections listed above. The ending number should match the ending cash position on your balance sheet. If it doesn’t, you’ve made a mistake somewhere along the way.

Preparing a cash flow statement can be a little tricky. If you need help, our cash flow statement template can help you figure out exactly where to plug in the numbers from your financial statements.

Step 3: Analyze your company’s cash flow

Now that you’ve prepared your cash flow statement, you want to look at trends and outliers that give you information about the health of your business. Here are a few questions to ask as part of your analysis:

  • Do you have positive cash flow or negative cash flow? Ideally, you’ll have positive cash flow—especially from your business activities. Positive cash flow from business operations is known as free cash flow. It’s a good indication that you’re producing enough cash to support the growth of the business.
  • If you have negative cash flow, why? Negative cash flow isn’t always a bad thing. For example, say you’ve built up significant cash reserves over the past few years and decided to reinvest it into your company by buying a commercial building and new equipment. This year’s cash flow might take a hit, but if those investments generate growth in revenue over the next several years, it could be well worth it.
  • If you have positive cash flow, why? Just as negative cash flow isn’t necessarily bad, positive cash flow isn’t necessarily good. For example, say you had to take out a loan to provide working capital because profits are down and you’re struggling to pay the bills. Your cash flows from financing activities would show positive cash flow only because you’ve taken on more debt.

What can a cash flow analysis tell you about your business?

Since cash is essential to running a small business, it’s easy to fall into the trap of thinking cash inflows are good and cash outflows are bad. But that’s not always the case. It depends on where the money is coming from and where it’s going.

To help you understand how to perform a financial analysis on your cash position and what it can tell you about your business, let’s look at a cash flow analysis example for a fictional company: Carla’s Canary Cage Cleaning.

Here’s Carla’s cash flow statement:

Cash Flow Statement: Carla’s Canary Cage Cleaning

Year Ended December 31, 20XX
Cash at Beginning of Year: $15,000
Cash Flows from Operating Activities
Net Income $80,000
Adjustment for depreciation 5,000
Adjustment for increase in inventory (20,000)
Adjustment for decrease in accounts receivable 10,000
Net Cash Flow from Operations $75,000
Cash Flows Investing Activities
Cash receipts from sale of property and equipment $15,000
Cash paid for purchase of equipment (10,000)
Net Cash Flow from Investing $5,000
Cash Flows from Financing Activities
Cash paid for loan repayment ($4,000)
Net Cash Flow from Financing ($4,000)
Net Increase in Cash $76,000
Cash Balance as of December 31, 20XX $91,000

Looking at her cash flow statement, we can tell several things about the financial health of the business. First, Carla had a net increase in cash of $76,000 for the accounting period. That’s good.

Second, Carla’s cash flows from business operations made up the majority of that increase in cash. That’s excellent because it means Carla has strong sales revenues and is managing expenses well.

Next, Carla sold some equipment she didn’t need anymore and purchased new equipment. Reinvesting into the business is usually a good move!

Also, we can see from the Financing Activities section that Carla didn’t take on any new short-term or long-term debt this year. Instead, she’s working on paying down the amount she owes to lenders.

However, Carla is sitting on a large amount of cash at year-end, so she might want to consider how she could use that money to grow the business or improve her quality of life. For example, Carla might use that cash to:

  • Hire another employee so she doesn’t have to work seven days a week
  • Make additional capital expenditures that would help her clean twice as many bird cages in the same amount of time
  • Pay off her loan balance to save on interest expenses and free up more cash for other uses
  • Pay herself a dividend, as a way to reward herself for her hard work building the business to this level of success in a short period of time

The right move depends on Carla’s goals and plans for the coming year. The bottom line is that without performing a cash flow analysis, Carla wouldn’t know where her cash is coming from or going. This analysis gives her greater visibility into her business operations and allows her to do some forecasting to decide how she should grow her business in the future.

So how do you find the time to create these reports, if you’re already stretched thin running your business? You bring in some help. With Bench, you get an expert bookkeeping team to compile all your transactions each month and create a monthly balance sheet, income statement, and other visual reports to help you understand your cash position and grow your business. Try Bench for free and get a set of financial statements to keep.

The bottom line

Overall, understanding your cash situation is crucial for evaluating the health of your business and making decisions. The more precarious your cash position, the more frequently you should perform a cash flow analysis. That way, you’ll spot trends and potential issues before they become big problems.

Above all, don’t be afraid to give analyzing your cash flows a try. Even if reading financial statements isn’t your strong suit, an imperfect analysis provides more information than none at all. As you learn more about your cash inflows and outflows, you’ll get better at financial modeling and feel more in control of your business finances.

This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. Bench assumes no liability for actions taken in reliance upon the information contained herein.
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