What is a cash flow analysis?

A cash flow analysis is the regular review of a business’s cash flow statement. It will tell you how much cash is moving in and out of your business and if there are opportunities or issues with cash flow to address. If you have a cash flow forecast, you can also review projected cash balances for the coming months.

Comparing your plan to actual results in the P&L and balance sheet is pretty straightforward. However, doing a cash flow analysis—that is, reviewing your cash flow statement—can be a bit more confusing.

That’s because the cash flow statement shows, for the most part, changes to different areas of your business rather than absolute numbers. 

Check out our detailed cash flow statement guide for a full rundown of how your cash flow statement works and an explanation of each row. 

Why cash flow analysis is important

Conducting a regular cash flow analysis will help you understand: 

• •If you’re generating positive or negative cash flow.
• •How much cash you will have in the future and how long will it last.
• •If there is cash available to reinvest in business growth.

To get a complete picture of your business finances,  you should also review your profit and loss statement (also known as P&L or income statement) and balance sheet. You must review each financial statement on its own and alongside the other statements. 

This is especially important when it comes to your P&L and cash flow statement. 

The P&L shows your profit—how much you make after subtracting costs and expenses from sales. If you just look at this statement and see a positive profit, you’ll walk away thinking your business is doing great.

However, profit on paper does not guarantee that you generated positive cash flow in the same period. The opposite may even be true. You may have unintentionally used cash to cover expenses to bring on more customers or sell more products. Or generated a lot of sales but customers are slow to pay and you won’t be paid until next month.

In this case, you have more sales and may be profitable, but don’t have more cash in the bank. 

But you wouldn’t know that if you only looked at your P&L. Again, this is why it’s so important to analyze your cash flow statement alongside your other financial statements. 

What you need to conduct a cash flow analysis

You just need your cash flow statement and cash flow forecast to conduct a cash flow analysis. Use these documents to compare current results against your projections. 

As mentioned above, you should also review your cash alongside the P&L and balance sheet. These are not needed to conduct a cash flow analysis but should be part of any larger analysis of your business finances.

Tip

While not required, I highly recommend you invest in a tool that offers pre-built performance dashboards. It will take the manual work out of updating and comparing your financial statements so you can jump right into your analysis.

If you’re not ready to invest in software yet, using a well-structured cash flow template can still save you a lot of time and effort. It will just require regular manual adjustments to keep it up to date.

How to do a cash flow analysis

Even if you fully understand how to read your cash flow statement and forecast, you likely have a few questions to answer as part of your monthly financial review. 

Here are the five most common questions and explanations so you can understand what to look for when performing a cash flow analysis.

1. Profits are up, so why don’t I have more cash in the bank?

This is probably the most common question I hear from business owners. In this case, your sales have been great and you’ve been keeping to your expense budget. 

This has led to solid profits, but your “net change in cash” (the amount of cash generated that your business added to its bank account) isn’t as much as you’d hoped. 

How can this be?

Profits and cash aren’t the same thing

The simple answer is that profits and cash are different things. 

Just because you made sales doesn’t mean that your customers actually paid you. If you’re like most businesses and you invoice your customers, they may take some time to pay you.

To see if this is the case, you’ll want to look at the “change in accounts receivable” line of your cash flow. 

If this number is low, or even negative, this means that your customers haven’t paid you very much even though you’ve booked the sales already.

You paid your bills or had a change in accounts payable

When you pay your bills can also impact your cash situation. If you paid more bills than you originally planned, this will reduce your cash. 

Look at your “change in accounts payable” line of your cash flow. If the number here is more than you planned, then you paid more bills than expected. 

This could be O.K. because you don’t want to build up a lot of unpaid bills, but could easily be the source of your reduced cash.

Some of your cash is tied up in inventory

You should also take a look at your “change in inventory” line of your cash flow statement to see if that’s where your cash went. 

If the number is lower than expected, it could be because you needed to purchase more inventory to support your increased sales. The number could even be negative if you purchased more inventory than you sold. 

This could be a good thing in the big picture for your business and might explain where your cash is going.

2. Is a negative change in accounts receivable a good thing?

There’s, unfortunately, no right answer to this question. The real answer is “it depends.” 

First, let’s look at what a negative number in “change in accounts receivable” means. 

A negative number means that customers owe you more money and haven’t paid you yet. So, what could have caused this increase in outstanding invoices to occur? 

Well, there are likely two reasons.

Your sales increased 

One reason this number might be negative is because of increased sales.

If your sales increased more than forecasted, you sent out more invoices and your customers just haven’t paid you yet. You’ll want these customers to pay eventually, of course. 

You’re not collecting fast enough

Another reason the number may not be as high as you want it to be is that you’re not collecting from your customers fast enough. You may need to chase down delinquent customers and make sure they pay their invoices.

Either way, you want enough saved to avoid burning through cash and ending up with nothing in the bank while you wait for customers to pay you. 

That’s why you’ll not only want to compare your actual results to your plan but revise your plan so that you have an accurate cash flow forecast and understanding of your cash runway moving forward.

3. Should I be concerned about a larger-than-planned change in accounts payable?

Again, the answer here is “it depends.” 

A larger than planned number in “change in accounts payable” means that you are collecting bills that you need to pay eventually and just aren’t paying them yet. 

Maybe this is O.K. and you don’t need to pay your bills yet. But, you don’t want to be delinquent in your payments either. 

If you’re short on cash, delaying some payments may be a good idea. 

Keep an eye on this number over the next few months and make sure it doesn’t continue to be significantly more than you planned. 

4. What does a larger change in inventory mean for my business?

If you have a positive number in the “change in inventory” line of your cash flow, that means you’ve sold more products to your customers than you’ve bought from suppliers during the month. 

Conversely, if the number is negative, you’ve purchased more inventory from your suppliers than you’ve sold to customers. 

Neither situation is “bad” for your business—it really depends on how much inventory you like to keep on hand and how frequently you purchase inventory. 

If you own a bike shop, for example, you may only purchase new inventory a few times a year. If you own a grocery store, you’re likely purchasing new inventory several times a week.

So, if “change in inventory” is a larger (more positive) number than you had planned, you’ve sold more product than you’ve purchased and you may need to order more inventory soon.

If “change in inventory” is smaller (more negative) than you had planned, you’ve purchased more inventory than you’ve sold and maybe you need to focus more on sales before buying more inventory.

5. What if the net change in cash isn’t as positive as planned?

The “net change in cash” line of your cash flow totals up all of the cash inflows and outflows in your business. 

It’s essentially the amount of cash that you’re either adding to (or subtracting from) your bank account. 

• •If the number is positive, your cash balance has grown during the month. 
• •If the number is negative, you’re ending the month with less cash than you started with.

If the number is not as positive as you had hoped, there are a few places to start looking. 

Accounts receivable

First, maybe your customers aren’t paying you as fast as you had hoped. If your “change in accounts receivable” line is negative, this is a good indicator that you’re owed some money. 

Check your balance sheet to see exactly how much you are owed.

Accounts payable

Second, check your accounts payable. Maybe you’re paying bills faster than planned and you should slow down. Again, refer to your balance sheet to see if your accounts payable balance is lower than expected.

Inventory

Third, check your inventory. If you made extra inventory purchases, this can certainly impact your cash position.

Sales and expenses 

Of course, you should also be looking at your overall sales and expenses. If you’re on track with sales and expenses, then looking at the three issues outlined above is the best place to start. 

If you’re off track with sales or expenses, that will also impact your cash position and require a closer look at your profit and loss statement.

Cash flow analysis example

Let’s look at an example, in this case, we’re looking at a service-based business that doesn’t hold inventory (so that line item is not represented on the cash flow statement).

The net change in cash (2nd row from the bottom) is positive, but it’s far lower than expected. Why is that the case? Well, if we run through the steps described above we can find out. 

• •Net profit was higher than expected meaning that some combination of higher sales and lower expenses occurred.
• •Change in Accounts Receivable are slightly lower than expected. If that were the only difference, we would see a larger increase in our final cash position.
• •Change in Accounts Receivable shows a large amount was paid out compared to the forecast. We had expected to accrue more bills and leave them unpaid for the month—not to pay off outstanding debt.

So, in this instance, the lower net change in cash came from paying more bills than expected (a negative change in AP vs a positive change).

Next steps

If this were your business, for the next few months you’d want to review your payment terms and account for all bills coming due. The unexpected bill payments worked out well this time, since you still ended with positive cash flow, but that may not always be the case.

Use your cash flow analysis to guide business decisions

Reviewing your cash flow statement and comparing your plan to your actual results will tell you how cash is moving into and out of your business. More importantly, it will provide clues as to where to look to make changes in your business if things aren’t going quite as planned. 

When you’ve finished your cash flow analysis, you now have an opportunity to make strategic changes to your small business. 

Perhaps you need to negotiate better payment terms with your vendors or figure out how you can make your customers pay you faster. You might want to re-think when you reorder inventory and the size of those orders.

If the time spent reviewing your financials yields actionable ideas to improve your business—you’re managing your business smartly for growth.