Mastering cash flow analysis: A comprehensive guide

Cash flow analysis is an essential component of business strategy. The cash flow statement provides an overview of cash inflows and outflows for your business, including operating activities, investment activities, and financing activities. Understanding cash flow analysis provides business owners and investors with a picture of the company’s financial health.

Analyzing this data helps small business owners make decisions about cash flow, investments, and future growth. We’ll explore the basics of the cash flow statement as well as how to perform cash flow analysis for small businesses.

Key takeaways

• A cash flow statement gives an overview of how cash moves in and out of a business.
• Cash flow includes operating, investment, and financing activities.
• Cash flow statements can be prepared using the direct or the indirect method.
• Understanding cash flow is key to making informed financial decisions.

Table of contents

• What is a cash flow statement?
• Components of a cash flow statement
• Preparing a cash flow statement
• Analyzing cash flow
• Why cash flow is important
• Cash flow analysis example
• Common mistakes in cash flow analysis
• How FreshBooks makes cash flow analysis easy

What is a cash flow statement?

A cash flow statement is a financial statement that details how cash moves in and out of a business over a given period of time. This provides an overview of real cash flows and liquidity for a company. Understanding a cash flow statement is essential for making financial decisions and demonstrating to investors that a business is in good financial health.

Components of a cash flow statement

The cash flow statement has three main components: operating activities, investment activities, and financing activities.

Cash flow from operating activities

Operating activities refer to the company’s core business activities, including cash that flows in from revenue, interest, and dividends. The operating cash flow margin also includes cash outflows for everyday operations like wages, rent, utilities, and product manufacturing costs.

Positive net operating cash flow generally indicates that the business makes enough to cover its operating costs without factoring in external financing. However, negative operating cash flow can be a sign that the business is struggling to cover daily operating costs.

Cash flow from investment activities

Cash flow from investment activities covers long-term investments, including asset sales like property and equipment. Outflows include long-term investment purchases, capital expenditures, and securities investments.

Positive investing cash flow from interest payments and other sources is often considered a good sign, but it’s important to conduct an investing cash flow analysis to confirm. Negative cash flow in investment activities may simply mean that the business is expanding and investing in new machinery, real estate, and other assets. However, it’s important to balance investment cash flow with cash flow from operating activities to make sure there’s enough liquidity to support day-to-day operations. 

Cash flow from financing activities

Financing activities include a business’s external financing measures, like debt and equity. Stock and borrowing are used to generate cash inflow, while stock buybacks and debt repayment create cash outflow.

Cash generated from financing activities can be a key part of business expansion, but it must be supported by revenue growth that’s capable of paying down debt. Conversely, a strong cash outflow in the form of buybacks and dividends can signal to shareholders that the company is performing well.

Preparing a cash flow statement

There are two main methods for generating cash flow statements: direct and indirect. Both result in the same net cash flow information, but the preparation methods are different.

Direct method

The direct method lists all cash transactions, using receipts and payments to generate an overview of real business activities. While this method is usually more time-consuming and requires clear cash tracking, it’s also the best option for regulatory compliance and makes it easy to see the details of cash inflows and outflows.

Indirect method

The indirect method uses net income from the income statement, then adjusts for all non-cash items to produce a cash flow overview. This is the quicker method because it uses pre-existing financial statements. However, it doesn’t present a detailed look at where cash actually flows, which makes it less helpful for guiding day-to-day financial decisions.

Analyzing cash flow

When you analyze a cash flow statement, start by looking for trends and patterns in cash movement. This can include cash flows that remain consistent, for example, wages for employees who work set hours. This can also include cash flow changes, such as rising prices for inputs or growth in sales. 

Track which inflows and outflows are steady and which ones are changing. Looking across multiple cash flow statements can help identify whether fluctuations represent a one-off incident or whether they’re part of a larger pattern in your company’s cash flow.

Why cash flow analysis is important

Cash flow analysis isn’t just an overview of cash movement — it’s an insight into the business’s financial health and an opportunity to plan for the future. 

Understanding these patterns can help small business owners make informed financial decisions. Rising costs may signal that it’s time to look for a new supplier, while steadily rising sales revenue may mean your marketing strategy is delivering good returns. Being able to calculate cash flow and make informed predictions can also guide larger decisions around expansion and investment.

Cash flow analysis example

The following example shows a cash flow statement for a hypothetical business:

The business begins with a starting balance of $45,345. Their gross cash inflow is $10,500, while gross cash outflow is $8,500, giving them a positive net cash change of $2,000. 

In this example, cash inflow is generated entirely through sales operating activities. Expenses come from operating activities ($4,500 in expenses), investment activities ($2,500 in equipment purchases), and financing activities ($1,500 in loan payments). 

If these cash flows remain consistent, the company is on track to continue generating profits. However, the business owner may also choose to adapt some strategies to try to increase profits. Currently, investing activities and financing activities both have a negative cash flow. The company may want to change its investing strategy, or consider options for paying down the loan more quickly to reduce interest payments. 

Analyzing cash flow statements like the above example can help business owners stay on track of positive and negative cash flow and make effective business decisions to maximize profits. 

Common mistakes in cash flow analysis

Cash flow analysis is essential for financial planning, but it must be used in conjunction with other financial metrics to present a complete picture of financial health. The following issues are common mistakes that can arise when performing cash flow analysis:

Looking at cash flow in isolation

While cash flow analysis focuses on the cash flow statement, it’s important to remember that cash flows exist as part of larger business operations. This means that in some cases, something on the cash flow statement may be related to a non-cash item such as depreciation or amortization. Before making major decisions based on cash flow, review non-cash items and make sure that all effects are considered.

Looking at only one cash flow period

A cash flow statement covers a given time period, usually a month, a quarter, or a year. However, many organizations have a cyclical business cycle that may extend beyond the time period covered by one (or even several) cash flow statements. It’s important that the cash flow statements being analyzed cover the full range of the business cycle to provide a real overview of trends, rather than representing an outlier range.

Missing cash flow components

Operating cash flow is often the most visible element of cash flow since it involves day-to-day business activities. However, it’s important to remember investment and financing activities and how these interact with operating cash flow. For example, operating cash flow may be necessary to fund some investment activities, so all parts of the cash flow statement must be considered together.

How FreshBooks makes cash flow analysis easy

Comprehensive cash flow tracking is essential for generating a detailed cash flow statement. The direct method is the best for making financial decisions, but it requires good tracking — that’s where FreshBooks comes in. 

FreshBooks expense and receipt tracking software makes it easy to track cash flow so you can generate accurate financial statements. Automated features allow you to effortlessly track income and expenses, create real-time financial and cash flow statements, and integrate with your bank for a full picture of your transactions. Try FreshBooks free to get started with cash flow analysis.

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