Cash Flow Analysis and Forecasting for Small Business Made Easy

Cash flow analysis and forecasting can make or break a small business, but it’s not always easy to know where to start if you don’t have a background in finance or accounting.

Cash flow analysis and forecasting can make or break a small business, but it’s not always easy to know where to start if you don’t have a background in finance or accounting. On this page, we’ll provide a foundation of business finance concepts and cover:

  • Why cash flow matters and how it can impact your business even if it’s profitable.
  • What a cash flow analysis is, why it matters, and how to perform one.
  • What cash flow forecasting is, why it matters, and how to make projections.
  • What to do if your forecast predicts a cash flow shortfall.

Quick Definitions

Let’s start by defining some terms that will be used throughout this page. Use this section as a primer and refer to it as needed.

How Does Cash Flow Affect a Business?

Many small business owners focus on profit – whether the business makes money over a set period of time. While profit is important, it’s actually poor cash flow management that’s behind eight in ten small business closures, per the National Federation of Independent Business (NFIB). This is because cash flow impacts:

Think of it this way: even if your business can turn a $1,000 investment into $10,000, your doors will close if you can’t get $1,000 to cover your operating expenses.

Why is Cash Flow Analysis Important?

A cash flow analysis provides clues into a business’s overall financial health. Businesses and investors often analyze cash flow as the first step in cash flow planning and to identify:

Why is Cash Flow Forecasting Important?

Cash flow forecasting takes financial planning to the next level. Businesses often forecast or project cash flow to:

What is a Cash Flow Statement?

A cash flow statement (CFS) summarizes a business’s cash inflows and outflows. A CFS can help a business understand how well it’s operating, where money is coming from, and how it’s being spent. Creditors will often request a copy of a business’s CFS before offering a loan because it offers insight into liquidity and how easy it will be for the business to make loan payments.

A CFS usually breaks cash flow down into one of three groups:

Cash Flows from Operating Activities

CFOs on a CFS reflect how much cash a business generates from its products and services. For example:

Cash Flows from Investing Activities

CFIs on a CFS relate to cash inflows and inflows from a business’s investments. For example:

Cash Flows from Financing Activities

CFFs on a CFS include things like cash from banks and investors as well as cash to shareholders. For example:

How is Cash Flow Calculated?

There are two methods used to calculate cash flow: direct and indirect. The best or easiest way to calculate cash flow depends on whether the business uses the cash basis accounting method or the accrual basis accounting method.

  • With cash basis accounting, the business doesn’t count revenue or expenses until money changes hands.
  • With accrual basis accounting, the business counts revenue and expenses when an invoice is sent, or the business receives a bill. Most businesses use this method.

Direct Cash Flow Calculation Method

The direct cash flow method involves adding up all cash received (inflows) and all cash paid (outflows).

Indirect Cash Flow Calculation Method

With the indirect cash flow method, the business lists its net income first, then lists all its inflows and outflows, and the final net cash increase or decrease over the set period is calculated.

Direct vs. Indirect Cash Flow Calculation Methods

The direct cash flow method is the more accurate of the two because the figures represent the real cash the business has or does not have.

The cash basis accounting method becomes more complicated and time-consuming as the number of inflows and outflows grows. Because of this, most large businesses use the indirect cash flow calculation method instead.

Cash Flow Analysis: How is a Cash Flow Statement Interpreted?

Cash flow statements make it easier to gauge the financial health of a company and can often provide clues as to what stage of growth the business is in.

Positive Cash Flow

When a cash flow statement indicates the business has positive cash flow, it means there is more money flowing into the business than out during the specified period.

This is usually an ideal situation because it typically means the business can cover its expenses and invest in growth. However, positive cash flow is not the same thing as profit.

A business can have positive cash flow without turning a profit. For example, a cash injection into the business from a loan would create positive cash flow.

Negative Cash Flow

Negative cash flow means there is more money flowing out of the business than into the business during the specified period.

Again, this doesn’t relate to profit. For example, cash flow may be negative if the business saved for some time and then purchased new equipment during the specified period. Businesses that are rapidly growing or that invest in growth may also have negative cash flow.

Because of this, a single cash flow statement isn’t always helpful by itself. If you’re analyzing cash flow, it’s better to compare multiple periods and compare changes.

How is Cash Flow Forecasted?

Just as there are direct and indirect methods of calculating cash flow, there are direct and indirect methods for forecasting.

Direct Cash Flow Forecasting Method

The direct cash flow forecasting method requires that you have a complete list of all payables due during the period as well as all receivables expected during the period. Then, to complete the forecast, you simply add up each anticipated payable and receivable for the period.

Indirect Cash Flow Forecasting Method

The indirect cash flow forecasting method uses the income statement (P&L) and the balance sheet. Start with the net income, then add or subtract balance sheet items that either impact profit (but not cash flow) or cash flow (but not profit).

Direct vs. Indirect Cash Flow Forecasting Methods

The direct cash flow forecasting method works best for smaller businesses and is more ideal for short-term forecasting. For example, you might use the direct cash flow forecasting method to determine if you’ll be able to make payroll next month or if you can afford to make an extra loan payment to cut back on the interest paid overall. A large business might leverage the direct method if accuracy during a small window is essential.

As the number of inflows and outflows increases, the direct method becomes more complicated. This is why 98 percent of businesses use the indirect method, according to the textbook “Financial Accounting for MBAs.” It’s more suitable for large businesses and long-term cash flow planning.

With that said, there isn’t a singular “best way to forecast cash flow.” Businesses often switch between the two depending on why they’re conducting a cash flow forecast and the length of the period involved.

Be Prepared with Viva

It’s normal for businesses to have limited cash flow or even negative cash flow when they’re growing. By analyzing cash flow, you can get a clearer picture of how your business is performing and how your cash is being managed.

However, it only tells you what’s already happened, which means you can only take a reactive approach. Forecasting helps you identify what’s likely to happen, so you can take a proactive approach and either cut back on outflows or increase your inflows when you predict a tight or negative period.

That’s where Viva comes in. We accelerate payment on your B2B invoices, so you get cash when you need it without taking on debt. To learn more or get started, request a complimentary quote.

Greg DiDonna

About Greg DiDonna

Greg DiDonna, President and Partner of Viva Capital, is responsible for strategic planning and implementation of customer service, and business growth. Three-time award winner of Banker of the Year by Southwestern Business Development Finance Corporation

Comments are closed.