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A Small Business Owner’s Guide to Cash Flow Analysis

cash flow analysis

As a business owner, you know what bills you must pay each month to keep the doors open. When planning for those expenses, a cash flow analysis can help you see how much money you have on hand to cover monthly costs. Tracking your cash flow can help you make sure you don’t spend more than you actually have and, in some cases, help you to have some money left over at the end of the month.

What is a cash flow analysis?

To keep track of the money coming in and going out of your business, you must conduct a cash flow analysis. Much like a checkbook register, a cash flow analysis shows how much money you have on hand after paying your monthly expenses, said Robin McIntire, regional director of the Small Business Technology and Development Center at the University of North Carolina at Charlotte.

Cash that is readily available could come from several sources, including sales or revenue, investments, loans and the sale of assets. That money flows out to cover operating expenses, debt and direct expenses.

Cash flow is not the same as profit, which represents sales revenue after expenses have been subtracted, McIntire said. Instead, a cash flow analysis examines your income and spending on a monthly basis.

Tracking when your business receives money can help you better budget for regular expenses like payroll and insurance bills and ultimately avoid a cash shortfall.

Why it is important for your business

For startups, a cash flow analysis could determine whether they thrive or flounder. Businesses could quickly fold if they do not correctly project how much money they’ll need to operate in their early days, McIntire said. However, all businesses should regularly conduct a cash flow analysis to keep an eye on available funds.

“Not enough people pay attention to it and it can really be the downfall of businesses, particularly businesses that are just starting out,” McIntire said.

Mapping out when you plan to receive money and when you are expected to pay bills helps you avoid falling behind on payments and potentially losing your business. Additionally, you may have to conduct a cash flow analysis when applying for funding at a traditional bank. Before handing out a loan, banks want to make sure a business is generating enough cash to take on debt, McIntire said.

What affects your cash flow?

A number of factors affect your business’ cash flow, McIntire said, such as how quickly your customers pay you and when you pay your suppliers or vendors. For instance, if you sell to customers on terms, such as 30 or 60 days, you must plan for that lapse between when you make a sale and when you actually receive money, McIntire said.

Alternatively, if you pay your suppliers or vendors the entire amount you owe upfront, you have less cash on hand for the remainder of the month. But paying in installments or adjusting your billing schedule near the end of the month helps to keep more money in your pocket, McIntire said.

Understanding the timing of your income is one of the keys to successfully running a business. McIntire has seen business owners, especially new ones, expect to receive a much higher amount of money in one month than they actually get. They mistakenly think they have a profit problem rather than a cash flow one.

“They may not understand that it has a name and there are ways for you to manage it and be more in control of it,” McIntire said.


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How to create a cash flow statement

A savvy way to understand your cash flow is to conduct an analysis. There are two ways that McIntire recommends to clients at the Small Business and Technology Development Center. You may also need your income statement, balance sheet and accounts payable records for your review.

The simplest technique is to take a red pen, a green pen and a calendar and write down your money expectations for each day. Red represents money going out and green represents money coming in. If you see a lot of red without much green in between, you might have a negative balance at the end of the month. The calendar method is best for business owners who are facing day-to-day money challenges, McIntire said.

The second method requires a spreadsheet, which is the most common format for a cash flow analysis, McIntire said. Each column represents a month and the rows represent money that the business is receiving and the expenses that must be paid. At the end of each column is the cash that remains at the end of that month, and that figure is added to the second column representing the next month.

Each column would generally include three subsections that captures that month’s cash flow analysis:

  • Operating activities: These activities are generated from your company’s core business activities and typically include sales, purchases and expenses.
  • Investing activities: These activities include the purchase or sale of long-term assets such as property and equipment and other financial investments.
  • Financing activities: These activities include new borrowing and loan repayment along with the issuance or buyback of company stock.

There are two methods for preparing a cash flow spreadsheet. The direct method entails listing all cash that you’ve received and paid during the month under the operating activities section, such as cash from customers and cash paid to suppliers, McIntire said. The indirect method lists your business’ net income under operating activities, adjusting for non-cash revenue and expenses to convert the total net income to cash amount.

The total cash amount in the operating activities section is the same for both methods but presented in a different format. The investing activities and financing activities sections are also the same for both methods. Small businesses typically use the direct method because it is simpler to list cash flow over a period of time, while large corporations tend to use the indirect method to show the company’s monthly cash compared to income, McIntire said.

Business owners should prepare a cash flow analysis either every month or every quarter to find opportunities to adjust spending, said Alexander Koury, CFP and wealth advisor for Values Quest in Phoenix, Ariz. “It should be part of the ongoing planning portion of the business,” he said.

Generally, projections of future cash flow should be limited to one or two years, McIntire said. Any estimations beyond that can get murky since factors change over time. However, some loan applications may require a three- to five-year cash flow analysis if you’re planning a special project such as expanding your business. In that case, it’s best to prepare one to best of your ability, she said.

How to read a cash flow statement

The main concern to look for in a cash flow analysis is a negative balance at the end of any given month, McIntire said. Once you spot one, examine the timing of money throughout the month to find where you may be overestimating your cash flow.

Also look for a pattern of increasing deficits. For example, if you notice a deficit in the same month of every year and it has gotten larger over time, you may have an underlying sales issue, McIntire said. Sometimes there is a deficit during months when a large payment is due, such as insurance or quarterly taxes. But if that negative number is becoming larger, you may need to make adjustments to your business model, she said.

Based on the information your cash flow analysis reveals, you should monitor your spending, taking note of areas where you could cut back to build up your cash reserves, Koury said. “As a business owner, when it comes to your expenses, ask yourself, ‘Are these justifiable things I need for my business to be running effectively?’” he advised.

To improve your cash flow over time, McIntire suggests allocating money for an upcoming expense or for a period when you anticipate a cash crunch. Bigger businesses sometimes put a cash flow management strategy in place, which include policies like not paying vendors for 90 days. Even established companies are not immune to money troubles, she said.

“Larger companies use their power to hold on to their money as long as they can,” McIntire said. “All businesses are subject to cash flow problems. All of them.”


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