How to Analyze Cash Flow Statements & Avoid Confusion

For business owners, knowing how to analyze cash flow statements is incredibly important. Cash flow describes how cash moves in and out of a business.

Most companies want to generate a strongly positive cash flow because it means they’re taking in more money than they spend. However, there are many sources of cash flow and not all are made equal, so knowing how to analyze a cash flow statement can help you understand where a company’s money is coming from.

How to Analyze Cash Flow?

• Cash flow describes the net movement of cash in and out of a business
• Not all cash flow is made equal – borrowing money still generates positive cash flow, but you’ll have to pay it back
• Profit and cash flow are not the same – cash flow measures money movement while profit shows financial success

How to Analyze a Cash Flow Statement

When you look at a business’s cash flow statement, you should see three sources of cash flow: operations, investing, and financing.

Step One: Analyze Cash Flow From Operations

Cash flow from operations is usually the first thing that shows up on a cash flow statement. It describes all of the cash received from customers and all of the money spent on operating expenses. This is the part of the statement to look at if you’re trying to find the cash flow generate by normal business operations.

Items that show up in this section include:

• Salaries
• Utilities
• Supplies
• Rent
• Accounts receivable
• Accounts payable
• Income taxes payable

Step Two: Analyze Cash Flow From Investing

Businesses often make large investments in real estate, equipment, vehicles, and other things that they’ll use for the long term. They may also choose to sell some of these investments down the road. These activities also generate cash flow.

A negative cash flow from investing can indicate a company that is investing in long-term expansion, meaning it’s not always a negative thing. Similarly, positive cash flow from investing might indicate a business that’s selling off essential equipment or properties to pay the bills, meaning it isn’t always a positive.

Some items included in cash flow from investing are:

• Property
• Buildings
• Equipment
• Vehicles
• Furniture
• Business acquisition
• Investment securities

Step Three: Analyze Cash Flow From Financing

Companies often raise money by selling equity or bonds or getting loans from banks. These activities also generate cash flow, which shows up in this section for a cash flow statement.

You’ll often see things like:

• Payment of dividends
• Repurchase or sale of stock and bonds
• Cash received from a loan
• Money used to pay long-term debt

Cash Flow Analysis Example

This is a simplified example of how to do a cash flow analysis for a company.

Imagine a company that has a cash flow statement that looks like this:

• Cash Flow From Operations
  • Revenue - $75,000
  • Accounts receivable - $25,000
  • Supplies – ($5,000)
  • Salaries – ($40,000)
  • Rent – ($24,000)
  • Utilities – ($5,000)
• Cash Flow From Investing
  • Vehicle purchase – ($25,000)
• Cash Flow From Financing
  • Money received from loan - $100,000
  • Loan payments – ($10,000)

The company’s cash flows for each category are:

• Operations - $25,000
• Investing – ($25,000)
• Financing - $90,000

That makes the company’s net cash flow $91,000

Tips for Conducting a Cash Flow Analysis 

When conducting a cash flow analysis or planning for the future of your company, these are some things to look out for.

Make Positive Cash Flow Your Goal

One of the goals of every business should be to generate positive cash flow. If your company has negative cash flow, that means your bank account balance is steadily decreasing. Eventually, you’ll run out of money to pay your bills.

Positive cash flow means your company is sustainable and can keep operating and growing.

Look for Irregular Cash Flow Patterns

One thing to keep an eye out for in cash flow statements is any unusual or irregular pattern. In most healthy businesses, cash flow from operations should be positive and cash flow from investing typically negative.

If that situation is flipped, it could indicate a company selling assets to pay its bills, which is a bad sign.

Analyze Your Negative Cash Flow

If a company’s cash flow is negative, take the time to figure out why. While negative cash flows usually aren’t a good thing, there are scenarios where it is expected or even a positive.

For example, a business that has a positive operating cash flow but a negative cash flow from investing could simply be spending money on growth, hoping to increase future revenue.

Calculate Your Free Cash Flow

Free cash flow is a popular measurement for business owners who want to get a closer look at how much extra cash their business generates. 

Free cash flow looks at how much money takes in after it pays operating and capital expenses. The amount left over is the cash the company can put toward things like paying off loans, initiating stock buy backs, or acquiring other companies.

Determine Your Cash Flow Margin Ratio

A company’s cash flow margin shows how efficient it is at turning sales into cash. The higher the margin, the better.

To calculate cash flow margin, use this formula:

Cash flows from operating activities / net sales = cash flow margin

For example, a company that brings in $150 in net sales and spends $120 on things like wages and supplies will have a cash flow from operating of $30. That puts its cash flow margin at 20%, which means 20% of every dollar it makes in sales turns into positive cash flow.

Why Is Cash Flow Analysis Important?

Cash flow analysis is important for business owners for many reasons.

The big one is that there is often a lag between making a sale and collecting payment. For example, if you’re a business-to-business supplier, you likely deliver goods to clients, send an invoice, and wait a few weeks to a month to get paid.

In the meantime, you don’t have cash, just an IOU, and you can’t spend an IOU to pay your own suppliers. Cash flow analysis lets business owners keep an eye on inflows and outflows of money and understand if they have sufficient working capital to pay the bills.

This is especially important for businesses that use accrual rather than cash accounting. Under accrual accounting, the company books the income when it’s earned, even if it has yet to receive payment.

How Can a Cash Flow Analysis Help Your Business?

Cash flow analysis can help your business in many ways.

Plan for Upcoming Expenses

Understanding your cash flow is essential when it comes to planning for upcoming expenses.

For example, if you know you have a big bill coming due, you want to make sure you have enough positive cash flow to cover that expense. Cash flow analysis will let you predict the amount of money you’ll have on hand and you can make adjustments to increase cash flow as needed.

Increase Your Income

Cash flow analysis lets you figure out where your money is coming from and where your money is going. You can use this information to streamline your business and boost your income.

For example, if you notice that your operating cash flow is low because you have very high supply costs, you can try finding less expensive suppliers.

Reconsider Your Payment Schedules

You can use a cash flow analysis to track your company’s income and spending and consider the best schedules for paying your bills.

For example, you might notice that most of your customers pay you in the middle of the month. If you can negotiate with your suppliers to let you pay them at the end of the month, you can ensure you’ll have enough money on hand to make those payments