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Cash Flow Analysis: Your guide to know everything

Cash flow analysis is an essential aspect of the financial management of a company. It gives information about the cash available to pay bills and make purchases.

Investors and analysts examine cash flow for various reasons, as it underscores the money needed to run and grow the business. Another reason for examining cash flow is for insights into a company’s financial stability.

Importance of cash flow analysis

Running a business without cash is almost impossible. For the success and longevity of a company, it needs enough money to purchase the needed assets, pay the bills and operate the business in a way that generates profit.

It is essential for a company to understand how much cash it already has and how well it is generating cash. It allows the company to take corrective action whenever needed.

cash flow analysis

Tracking your finances can help you place yourself in a better position to plan company operations and business activities that lead to profits and growth.

With cash flow analysis, you can examine the cash flowing in and out of a company, i.e., where it comes from and where it goes. The ‘net cash flow’ figure is calculated by subtracting the current liabilities from current assets for that specific period. This analysis looks at a specific period of time for various activities such as financing, operations and investment.

While positive cash flow represents that the company’s financial health is good, continued negative cash flow is a sign that the company might be in financial trouble.

The cash flow of a company can be determined using the figures that appear on the statements of cash flows. You will need to examine each part of the business that has an effect on cash flow if you wish to perform an effective cash flow analysis.

Please note that cash and earnings are two different terms. Earnings happen in the present when an expense and a sale are made. Cash inflows and outflows, on the other hand, can occur at a later date. Thus, it is essential to understand the difference between the two when managing your business payments.

Cash flow statement

A company needs to prepare a cash flow statement that contains all the cash inflows received from its ongoing operations as well as external investment sources and cash outflows that pay for its activities and investment for a quarter.

There are three different sections that the cash flow statement covers: cash flow from investing (CFI), cash flow from operating activities (CFO) and cash flow from financing activities (CFF).

Cash flow from investing

The cash flow from investing activities takes long-term uses of cash into account. It may include the purchase or sale of a fixed asset like equipment or property. Proceeds from the sale of any division or a cash-out because of a merger can also be included in it.

Cash inflows come from sales, assets and securities. Usually, investors monitor capital expenditures used for the physical assets of the company to see how the organisation invests in itself.

Cash outflows are generated from the purchase of investment securities, capital expenditures for equipment and properties and other investing transactions.

The cash flow from investing activities section on the cash flow statement reveals the cash flow from purchases and sales of long-term investments such as fixed assets. Purchase of certain items like vehicles, furniture, land or buildings can be included in this section.

Cash flow from operations

Cash flow from operations shows accounting for cash inflows received from normal business operations along with their respective cash outflows. This includes the spending or any source of cash that comes from the day-to-day business operations of a company.

Operating cash flow is generated from normal operations as well, subtracting the interest and taxes paid. Changes that take place in the current assets and liabilities are recorded as operating cash flow, too.

The “Cash flow from operations” section of the cash flow statement reveals the amount of cash from the business’s income statement that was initially recorded on an accrual basis. The following items are included in this section:

  • Accounts payable
  • Accounts receivable
  • Income tax payable

You have to calculate the cash generated from customers as well as the cash paid to suppliers if you want to calculate cash flow from operating activities.

cash flow analysis

The difference between these two is the amount that will represent cash flow from operations.

Cash flow from financing

Transactions involving debt, equity and dividends are included in financing activities. The cash flow from the financing activities section of the cash flow statement shows the net funds of cash used to fund the company. Different cash flows fall under this section, such as

  • Cash received from a loan
  • Payment of dividends
  • Cash used for repayment of any long-term debt
  • Repurchase or sale of bonds and stocks

Cash flow from financing activities gives investors insights into the financial health of a company along with how well the capital structure is managed. Dividend-paying businesses need to focus on this section since it shows cash dividends paid, as believed by investors.

The following formula is used by the analysts to figure out if the business is on sound financial ground:

Cash Flow from Financing = Cash inflows from issuing equity or debt – (Cash paid as Dividends + Repurchase of debt and equity)

Cash flow analysis

The cash flow of a company is the figure that is present at the bottom of the cash flow statement. It may also be known as net change in cash account or ending cash balance.

The cash flow is also known as the net cash amounts from different sections, i.e., operations, investing and financing.

What’s surprising is the fact that there isn’t any universally accepted definition of cash flow. A lot of financial professionals believe the net operating cash flow to be the addition of a company’s net income, depreciation and amortisation. Although this interpretation comes quite close to net operating cash flow, it can be inaccurate.

Thus, investors need to stick to using the net operating cash flow amount from the cash flow statement. Even though cash flow analysis includes several ratios, the indicators given below can help the investor measure the investment quality of the cash flow of the company.

cash flow analysis

Operating cash flow/ Net sales

This ratio is expressed as a percentage of the net operating cash flow analysis of the company to the net sales. It represents how many dollars of cash have been generated for each dollar of sales.

The higher the percentage of this ratio, the better. In addition, the industry and company ratios also vary widely. Tracking this indicator’s performance historically will help with detecting significant variances from the average cash flow and sales relationship of the company. It will also let you compare the company’s ratio to that of its peers.

You must monitor how cash flow increases when the sales increase, as it is essential that both move at a similar rate over time.

Free cash flow

Free cash flow is described as the net operating cash flow minus the capital expenditures.

It is an important measurement as it represents how efficient the company is at generating cash. Free cash flow is used by investors to determine if the company has enough cash (after capital expenditures and funding operation) to pay its investors through dividends.

In order to calculate cash flow statements, you have to find the item cash flow from operations, otherwise known as ‘net cash from operating activities’ or ‘operating cash’. Then, subtract capital expenditures needed for current operations from it.

It is essential to monitor free cash flow over numerous periods and compare the numbers to companies within the same industry. When the free cash flow is positive, it can indicate that the company is able to meet its obligations, which include funding its operating activities and paying dividends.

Cash Flow Analysis – Points to Remember

There are some major trends that can tell you a lot about the health of your business when it comes to cash flow analysis. The following points should be kept in mind when analysing cash flow:

Aim for positive cash flow.

If the operating income exceeds net income, it may be an indication that the company has the ability to remain solvent as well as sustainably grow its operation.

Be cautious of positive cash flow.

You need to be cautious of having positive investing cash flow but negative operating cash flow since this couple means there’s an issue. This might happen when a business is selling its assets to pay operating expenses. It will impact the sustainability of the business.

positive cash flow & negative cash flow

Analyse the negative cash flow.

Negative cash flow isn’t always a bad thing when it comes to cash flow analysis. It might mean that the business is making investments in equipment and property to make more products.

Bear in mind that a positive operating cash flow paired with a negative investing cash flow may signal that the company is making money and using it to grow.

Calculate the free cash flow.

Free cash flow can be of great advantage. It is the cash flow left after paying operating expenses and buying needed capital assets. Free cash flow can be used by a company to pay off debt, pay interest to investors, pay dividends or more.

Operating cash flow margin builds trust.

The operating cash flow margin ratio calculates cash from operating activities as a percentage of sales revenue in a specific period.

A positive margin represents that a company can convert sales to cash and is able to indicate profitability and earnings quality.


Although cash flow analysis is one of the best tools for finding out if the company is doing well, cash flow analysis has its own disadvantages. Here are a couple of these limitations:

  • The cash flow analysis does not consider any growth in the cash flow statement. This statement always represents what happened in the past. However, the past information might not be able to portray the right information about the business for investors who are interested in investing.
  • Another limitation of a cash flow statement is that it cannot be easily interpreted. It can be difficult to understand if a company is investing more in assets or paying off its debts from a cash flow statement. It will be challenging for investors to interpret the cash flow statement without the help of an income statement or other information regarding the transactions that took place throughout this period.
  • If you wish to understand the profitability of the firm, a cash flow statement might not be appropriate. Why? Because non-cash items aren’t considered in the cash flow statement. As a result, all the profits are deducted, and the losses are added back to the cash inflow or cash outflow.
  • The cash flow statement is based on the cash basis of accounting while completely ignoring the accrual concept of accounting.

Accrual Accounting vs Cash Accounting

There are two types of accounting used to determine how cash moves within the financial statements of a company: accrual accounting and cash accounting. However, a cash flow analysis does not consider accrual accounting. Thus, businesses that use this form of accounting may have difficulty while performing a cash flow analysis.

Let us understand the difference between these.

Accrual accounting is the one that is used by most of the public companies. In this method, as soon as the income is earned (not when the payment is received by the company), revenue is reported. Along with this, expenses are reported when they are incurred, even if cash payments haven’t been made.

When the payments are recorded when they are received and expenses when they are paid, it is known as cash accounting. In this method, revenues and expenses are recorded after the cash has been received and invoices have been paid.

Key Takeaways

Cash flow analysis is essential for multiple reasons. By engaging in an ongoing analysis, you can quickly identify the problems with incoming and outgoing cash. For instance, cash flow analysis will show when a company has revenue streams that are not able to produce as much as they should.

If the cash flow analysis shows that the business is running low on cash, it can make more informed decisions quickly. This is the easy why examining cash inflows and outflows is an essential aspect of painting a proactive accounting strategy.

Need some help? Clear Tax Accountants is here for you! We are your local tax accountants in Melbourne who are committed to helping the small business community by providing advice on local small business tax matters. 

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