For many small business owners, financial statements can be intimidating. Balance sheets, income statements, and cash flow statements may seem overwhelming at first, but they don’t have to be. The more time you spend with them, the more you will understand them. 

And that’s important because having a good understanding of your business financial statements can be extremely helpful both to better manage your business operations and to plan for growth. Financial analysis can help you understand things like the financial health of your business, what business activities are working, how accurate your forecasting was, and so much more. 

Other financial statements you’ll want to review include your balance sheet and your income statement. 

Cash Flow Analysis Formula

A cash flow statement, sometimes called a statement of cash flows, is especially important as it helps you understand how cash and cash equivalents have moved through your business throughout the year (or a specific accounting period), and your ending cash position. Cash equivalents can be quickly converted to cash, usually within three months. 

At its most basic method, cash flow statement analysis compares cash received with cash paid out. Cash received includes sales revenues as well as investment or interest income. Cash paid out can include any number of items including inventory, taxes, payroll, loan payments, etc. 

Just taking a simple approach can be helpful. But if you really want to understand your business cash flow you’ll discover there are more detailed ways to analyze it. 

Operating cash flow can help you understand whether your business has sufficient cash flow to maintain operations, without having to seek additional funding or financing. There are two ways to calculate operating cash flow: the direct method and the indirect method. 

The direct method is used by businesses using cash basis accounting. Here, cash inflows and cash outflows are all that is measured. 

The indirect method is used by companies that use accrual basis accounting and includes non-cash transactions as well as cash transactions. 

You may also want to analyze free cash flow, which indicates the money available to the business after operating expenses and capital expenditures have been paid. 

Note that whatever method you use,  you have to start with good data. That means you need your bookkeeping that’s up to date.

What if you haven’t started your business yet? A cash flow statement can help you plan your anticipated cash flow for your business. In fact, your cash flow statement can be a key part of planning a successful business, even if you have to make some educated guesses.

Cash Flow Statement Walk Thru

There are generally four main components to a cash flow statement:

• Cash flow from operating activities
• Cash flow from financing activities
• Cash flow from investing activities
• Net change in cash balance

These categories each contain important sets of information. 

Cash flow from operations includes net income, depreciation, amortization, changes in accounts receivable, changes in accounts payable, taxes payable, changes in inventory, wages, and items of that nature. 

Financing activities encompasses those used to finance your business. This can include notes payable, lines of credit, long-term debt, and short-term debt. Payments on a small business loan or business credit card repayment would be included in this section.

The third main category, investing activities, consists of capital expenditures, paying dividends, and other activities of a similar nature.

The pertinent numbers in each section allow you to see which ones have had positive or negative cash flows. These sections are then totaled so that you can quickly ascertain the net cash flow from all activities over a given period of time.

How Lenders Use Cash Flow Analysis

Lenders may use cash flow statements to quickly assess the liquidity (cash on hand) of the business. Positive cash flow can indicate a financially healthy business. It also helps lenders understand how much debt a business may be able to handle. 

Uncovering Opportunities With A Cash Flow Analysis

Opportunities go both ways when it comes to looking at cash flow analysis. Positive cash flow is generally a positive sign. It is showing you that you have more money coming in than going out which, at a glance, is good. However, you may still have room for improvement to grow your business, pay off debts, or upgrade equipment. If you’ve just been focused on maintaining positive cash flow, you may have failed to take advantage of these opportunities. 

Negative cash flow can be just as it sounds— negative— but sometimes it’s indicative of growth. While negative cash flow can definitely indicate a business is struggling financially, isn’t profitable, or has overstretched itself, it can also accompany a period of growth. It can indicate that a company is hiring more employees, investing in equipment, inventory or advertising, for example.

Ultimately determining that a company’s cash flow is negative or even positive shouldn’t be the beginning or the end of an evaluation of the health of the business. Rather the statement as a whole should be looked at and it should be a starting point to understand the business journey. 

Optimize Your Cash Flow For Business Loans

Even though it may be normal for a business to experience negative cash flow for a period of time, understand that it can hamper your ability to get a small business loan or financing. 

Some lenders may be willing to lend if your business has strong revenues, and the ability to make payments on a future loan. Many lenders will want to review three to six months of business bank statements.

You may have more financing options if you have good credit (personal and/or business credit) and are willing to provide a personal guarantee. Collateral can be helpful as well. 

Ideally, though, you want to try to plan ahead. While you may not feel like you need financing when you have a healthy amount of money in your business bank account, that may be the best time to apply for a line of credit or other types of financing you anticipate needing in the future. It’s best to apply for small business financing before you are in desperate need of cash for working capital.

Need to take control of your cash flow? Sign up with Nav to better understand your business finances, so you can make smarter money decisions.