How to Create a Cash Flow Analysis That Unveils Opportunities (2023)

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The importance of cash flowWhat is a cash flow statement?How is a cash flow statement prepared?Calculating cash flowAnalyzing your cash flow statement

As a business owner, how you manage your finances can make a huge impact — negative or positive — on the success of your business. Conducting a cash flow analysis and monitoring your income statement is the best way to gauge the health of your business and tells you whether it’s just making ends meet or is successful and flourishing.

Put simply, cash flow is the movement of money in and out of your business. That number determines when you need to cut back — if the amount of funds you have access to is low — or when it is time to invest and grow — if you have a lot of extra cash.

Poor cash flow management accounts for 82 percent of business failures, so performing a regular cash flow analysis can help you make the right decisions when it comes to operational activities and investing for your business.

The importance of cash flow

Without assessing cash flow, it’s difficult to predict your net income and how much money you have for payroll, suppliers, and growth. Understanding and keeping tabs on your cash flow is also helpful for knowing where you need to make adjustments if there’s a financial problem.

The best way to keep a close eye on the amount of cash generated from your business is to perform a cash flow analysis. A cash flow analysis gives you insight on your cash inflow, cash outflow, and provides a holistic view of your business’s financial well-being. And while it’s important for all businesses, it’s especially important for those just starting a business. When your business is getting up and running, you are bound to have higher labor costs, more equipment and supply expenses, and increased inventory.

To perform a cash flow analysis, start by examining the parts of your business that affect cash flow. This starting point includes accounts receivable, inventory, accounts payable, and credit terms. The best way to analyze and compare these parts is through a cash flow statement.

What is a cash flow statement?

A cash flow statement is a financial statement that summarizes the cash entering and leaving a company. There are a few circumstantial nuances you need to know in order to create a cash flow statement that will display how changes in the balance sheet and income affect cash equivalents. Cash flow for a company can be divided into three sections:

  • Cash flow from operating activities (CFO): This type of cash flow is the revenue-generating activities of a business. This shows how much a company has generated from its core business operations, and it’s generally only reported on quarterly and annual reports. Ideally your cash flow ratio should be 1:1 or close to it. This means you have enough income to cover your expenses and are capitalizing on extra funds to grow or invest in your business.
  • Cash flow from investing activities (CFI): This is an item on a cash flow statement that reports the change in a company’s cash position resulting from investment gains or losses. Changes to property, plant, and equipment are also accounted for here.
  • Cash flow from financing activities (CFF): This item in your cash flow statement accounts for external activities that allow your business to raise capital. Other financing activities are issuing stock to shareholders, buying stock back, making payments on a business loan, or distributing dividends.

How is a cash flow statement prepared?

To create a statement, there are a number of tools available. There are free templates available to download, or you can try accounting software like Square partner QuickBooks, which has a built-in cash flow forecasting report.

Calculating cash flow

Once you have your statement pulled together, you have the data points needed to calculate your cash flow.

The shortcut version of calculating your cash flow is to compare your total unpaid purchases to your total sales at the end of the month. If you find that unpaid purchases are more than your total sales, you are in danger of spending more than you have and running into a cash flow problem.

To calculate your cash flow using a cash flow template, follow these steps:

  1. Enter your company’s total cash balance at the beginning of a selected time period into the cash flow statement.
  2. Fill in your cash inflows and outflows in the abovementioned main categories: operating activities, investing activities, and financing activities.
  3. Combine the cash inflows and outflows, then add/subtract from your beginning total cash balance. Net cash flow (or your “bottom line”) is the increase/decrease in cash or cash equivalents.

Analyzing your cash flow statement

The more you run cash flow analyses, the more data you uncover and patterns you notice. For example, if you’re noticing that your cash flows falls into the negative toward the end of the month, that could be a clue that you’re overspending in the beginning of the month.

Validating a positive or negative cash flow is just one detail you can determine from your cash flow statement. Other ways to use your cash flow statement for insights into your business are:

  • Calculating free cash flow: Free cash flow refers to the funds you have available after paying capital and operational expenses. To calculate free cash flow, use one of these three approaches:
  • Free cash flow = sales revenues – operating costs and taxes – required investments in operating capital
  • Free cash flow = net operating profit after taxes (NOPAT) – net investment in operating capital
  • Free cash flow = net cash flow from operations – capital expenditures
  • Determining your operating cash flow to liabilities ratio: This ratio can help you understand whether your current liabilities are covered by your cash flow. In other words, this can help you gauge your company’s liquidity. Since earnings can’t be manipulated, using cash flow instead of income to calculate the ratio is more accurate. To calculate the ratio, divide your cash flow from operations by your current liabilities.
  • Identifying your operating cash flow to sales ratio: This ratio, expressed as a percentage, helps you compare your operating cash flow to net sales to get an idea of your company’s ability to turn sales into cash. If your business is healthy, you should see your company’s sales grow in parallel to your operating cash flow. To calculate the ratio, divide your operating cash flow by your net sales (revenue).
  • Identifying cash flow trends: Using the above ratios helps you track your business’s health and measure how you are managing cash. Once you have a year’s worth of financial data, you can analyze your month-over-month cash flow more accurately and start making changes to help your business grow and succeed.

It’s smart to perform a cash flow analysis at least once a month, but there’s no limit to how often you can do it. Depending on your industry and the current state of your business, you should choose the cadence that keeps you aware of your business’s financial status.

And as always, we recommend that you consult with an accountant or financial advisor if you have any questions about your books. They should be able to help you do a cash flow analysis or make sense of the results.

Running a business is no easy feat, but Square is here to help. We have all the tools you need to start, run, and grow your business, whether you’re selling in person, online, or both. And we’ve made all our tools to work together as one system, saving you time and money — and making decisions easier. So you can get back to doing the work you love and focusing on whatever’s next. See how Square works.

How to Create a Cash Flow Analysis That Unveils Opportunities (1)

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