Cash Flow Analysis and Statement

Citation metadata

Editor: Sonya D. Hill
Date: 2012
Encyclopedia of Management
Publisher: Gale, a Cengage Company
Document Type: Topic overview
Pages: 4
Content Level: (Level 4)

Document controls

Main content

Full Text: 
Page 108

Cash Flow Analysis and Statement

Cash flow analysis is a method of analyzing the financing, investing, and operating activities of a company. The principal goal of cash flow analysis is to identify, in a timely manner, cash flow problems as well as cash flow opportunities. The primary document used in cash flow analysis is the cash flow statement. The cash flow statement is one of three main financial reports for business operations. The other two are the income statement, which reveals the company's profitability, and the balance sheet, which reports the company's assets, liabilities, and owner equity. Together, the three reports provide an accurate picture of the company's overall stability. Since 1988, the Securities and Exchange Commission has required every company that files financial reports to include a cash flow statement with its quarterly and annual reporting.

The cash flow statement is useful to managers, lenders, and investors because it translates the earnings reported on the income statement into a simple summary of how much cash the company has generated during the period in question. “Cash flow measures real money flowing into, or out of, a company's bank account,” notes the company Financial Exchange in the glossary on its Web site. “Unlike reported earnings, there is little a company can do to over-state its bank balance.”


There are two basic approaches to creating a cash flow statement. The direct method uses real cash activities from cash receipts and payments. The indirect approach involves calculations based on changes in liabilities and assets such as cash and account receivables. A typical cash flow statement is divided into three parts: cash from operations (from daily business activities like collecting payments from customers or making payments to suppliers and employees); cash from investment activities (the purchase or sale of assets); and cash from financing activities (the issuing of stock or borrowing of funds). The final total shows the net increase or decrease in cash for the period.

Cash flow statements facilitate decision making by providing a basis for judgments concerning the profitability, financial condition, and financial management of a company. While historical cash flow statements facilitate the systematic evaluation of past cash flows, projected (or pro forma) cash flow statements provide insights regarding future cash flows. Projected cash flow statements are typically developed using historical cash flow data modified for anticipated changes in price, volume, interest rates, and so on.

To enhance evaluation, a properly prepared cash flow statement distinguishes between recurring and nonrecurring cash flows. For example, collection of cash from customers is a recurring activity in the normal course of operations, whereas collection of cash proceeds from secured bank loans (issuances of stock or transfers of personal assets to the company) is typically not considered a recurring activity. Similarly, cash payment to vendors is a recurring activity, whereas repayment of secured bank loans (the purchase of certain investments or capital assets) is typically not considered a recurring activity in the normal course of operations.

In contrast to nonrecurring cash inflows or outflows, most recurring cash inflows or outflows occur (often frequently) within each cash cycle (i.e., within the average time horizon of the cash cycle). The cash cycle (also known as the operating cycle or the earnings cycle) is the series of transactions or economic events in a given company whereby:

  1. Cash is converted into goods and services.
  2. Goods and services are sold to customers.
  3. Cash is collected from customers.

To a large degree, the volatility of the individual cash inflows and outflows within the cash cycle will dictate the working-capital requirements of a company. Working

Page 109  |  Top of Article

capital generally refers to the average level of unrestricted cash required by a company to ensure that all stakeholders are paid on a timely basis. In most cases, working capital can be monitored through the use of a cash budget.


In contrast to cash flow statements, cash budgets provide much more timely information regarding cash inflows and outflows. For example, whereas cash flow statements are often prepared on a monthly, quarterly, or annual basis, cash budgets are often prepared on a daily, weekly, or monthly basis. Thus, cash budgets may be said to be prepared on a continuous rolling basis (e.g., are updated every month for the next 12 months). Additionally, cash budgets provide much more detailed information than cash flow statements. For example, cash budgets will typically distinguish between cash collections from credit customers and cash collections from cash customers.

A thorough understanding of company operations is necessary to reasonably assure that the nature and timing of cash inflows and outflows are properly reflected in the cash budget. Such an understanding becomes increasingly important as the precision of the cash budget increases. For example, a 360-day rolling budget requires a greater knowledge of a company than a two-month rolling budget.

While cash budgets are primarily concerned with operational issues, there may be strategic issues that need to be considered before preparing the cash budget. For example, predetermined cash amounts may be earmarked for the acquisition of certain investments or capital assets, or for the liquidation of certain indebtedness. Further, there may be policy issues that need to be considered prior to preparing a cash budget. For example, should excess cash, if any, be invested in certificates of deposit or in some form of short-term marketable securities (e.g., commercial paper or U.S. Treasury bills)?

Generally speaking, the cash budget is grounded in the overall projected cash requirements of a company for a given period. In turn, the overall projected cash requirements are grounded in the overall projected free cash flow. Free cash flow is defined as net cash flow from operations less the following three items:

  1. Cash used by essential investing activities (e.g., replacements of critical capital assets)
  2. Scheduled repayments of debt
  3. Normal dividend payments

If the calculated amount of free cash flow is positive, this amount represents the cash available to invest in new lines of business, retire additional debt, or increase dividends. If the calculated amount of free cash flow is negative, this amount represents the amount of cash that must be borrowed (or obtained through sales of nonessential assets, etc.) in order to support the strategic goals of the company. To a large degree, the free cash flow paradigm parallels the cash flow statement.

Using the overall projected cash flow requirements of a company (in conjunction with the free cash flow paradigm), detailed budgets are developed for the selected time interval within the overall time horizon of the budget (i.e., the annual budget could be developed on a daily, weekly, or monthly basis). Typically, the complexity of the company's operations will dictate the level of detail required for the cash budget. Similarly, the complexity of the corporate operations will drive the number of assumptions and estimation algorithms required to properly prepare a budget (e.g., credit customers are assumed to remit cash as follows: 50 percent in the month of sale, 30 percent in the month after sale, and so on). Several basic concepts germane to all cash budgets are:

  1. Current-period beginning cash balance plus current-period cash inflows less current-period cash outflows equals current-period ending cash balances.
  2. The current period ending cash balance equals the new (or next) period's beginning cash balance.
  3. The current-period ending cash balance signals either a cash flow opportunity (e.g., possible investment of idle cash) or a cash flow problem (e.g., the need to borrow cash or adjust one or more of the cash budget items giving rise to the borrow signal).

Cash budgets can be maintained in a simple accounting ledger, or businesses can choose to use customizable spreadsheet software. Most accounting software programs are equipped with a basic cash budget application that will gather data from a designated database and create a snap-shot of details from the specified time period. For small business professionals, an Internet search will reveal several options for free, downloadable cash budget programs.


In addition to cash flow statements and cash budgets, ratio analysis can also be employed as an effective cash flow analysis technique. Ratios often provide insights regarding the relationship of two numbers (e.g., net cash provided from operations versus capital expenditures) that would not be readily apparent from the mere inspection of the individual numerator or denominator. Additionally, ratios facilitate comparisons with similar ratios of prior years of the same company (intracompany comparisons) as well as comparisons of other companies (intercompany or industry comparisons). While ratio analysis may be used in conjunction with the cash flow statement or the cash budget or

Page 110  |  Top of Article

both, ratio analysis is often used as a stand-alone, attention-directing, or monitoring technique.


In his book, Buy Low, Sell High, Collect Early, and Pay Late: The Manager's Guide to Financial Survival, Dick Levin suggests the following benefits that stem from cash forecasting (i.e., preparing a projected cash flow statement or cash budget):

  1. Knowing what the cash position of the company is and what it is likely to be avoids potential embarrassment. For example, it helps avoid the temptation to say the check is in the mail when it is not.
  2. A firm that understands its cash position can borrow exactly what it needs and no more, thereby minimizing interest, or, if applicable, the firm can invest its idle cash.
  3. Walking into the bank with a cash flow analysis impresses loan officers.
  4. Cash flow analysis deters surprises by enabling proactive cash flow strategies.
  5. Cash flow analysis ensures that a company does not have to bounce a check before it realizes that it needs to borrow money to cover expenses. In contrast, if the cash flow analysis indicates that a loan will be needed in several months' time, the firm can turn down the first two offers of terms and have time for further negotiations.


Many businesses fail due to inadequate capitalization. Inadequate capitalization basically implies that there were not enough cash or credit arrangements secured prior to initiating operations to ensure that the company could pay its debts during the early stages of operations (when cash inflows are nominal, if any, and cash outflows are very high). Admittedly, it is extremely difficult to perform a cash flow analysis when the company does not have a cash flow history. Accordingly, alternative sources of information should be obtained from trade journals, government agencies, competitors, and potential lenders, vendors, and customers. This allows the firm to learn from others' mistakes and successes.


While inadequate capitalization represents a front-end problem, unconstrained growth represents a potential back-end problem. Often, unconstrained growth provokes business failure because the company is growing faster than its cash flow. It is important to note that poor or lagging cash flow can happen to a business experiencing soaring sales. In fact, fast-growing companies are especially vulnerable because they have to maintain large inventories and pay employee costs while waiting for customer payments. In her article for , Jenny McCune quotes a remark made by Mark Deion, president of business consulting firm Deion Associates & Strategies Inc. in Warwick, Rhode Island: “For example, say it costs you $100,000 to produce something and a customer is willing to pay you $1 million. Now, $900,000 is a great profit margin. But what if you have to pay the $100,000 in December and your customer's not going to pay you until April?” Timing, as they say, is everything.

While many cash flow problems are operational in nature, unconstrained growth is a symptom of a much larger strategic problem. Accordingly, even to the extent that cash flow analyses are performed on a timely basis, such analyses will never overcome a flawed strategy underpinning unconstrained growth.


Generally speaking, cash flow problems are common in business. The main culprits are usually having too much cash tied up in receivables or inventory, having too many nonpaying customers, or having too much money going to overhead costs. If those factors are under control, the cash flow problems likely stem from weak gross margins, meaning prices are too low, business costs are too high, or both. Left unchecked, a business may ultimately face bankruptcy.

A company is said to be bankrupt when it experiences financial distress to the extent that the protection of the bankruptcy laws is employed for the orderly disposition of assets and settlement of creditors' claims. Significantly, not all bankruptcies are fatal. In some circumstances, creditors may allow the bankrupt company to reorganize its financial affairs, allowing it to continue or reopen. Such a reorganization might include relieving the company from further liability on the unsatisfied portion of the company's obligations. Admittedly, such reorganizations are performed in vain if the reasons underlying the financial distress have not been properly resolved. Unfortunately, properly prepared and timely cash flow analyses cannot compensate for poor management, poor products, or weak internal controls.


Brahmasrene, Tantatape, C. D. Strupeck, and Donna Whitten. “Examining Preferences in Cash Flow Statement Format.” CPA Journal 58 (2004).

Brodsky, Norm. “How to Fix Cash-Flow Problems.” Inc., 1 May 2009. Available from .

Page 111  |  Top of Article

Center for Business Planning. “Cash Flow Statement.” Austin, TX: Business Resource Software, Inc. Available from .

Clausen, James. “Accounting Cash Flow Sample–Direct Method.” , 5 March 2010. Available from–direct-method-a209838.

Financial Exchange. “M & A Finance Glossary.” Grimes, IA: Financial Exchange. Available from

“Fundamental Analysis: The Cash Flow Statement.” . Available from .

Levin, Richard I. Buy Low, Sell High, Collect Early, and Pay Late: The Manager's Guide to Financial Survival. Englewood Cliffs, NJ: Prentice-Hall, 1983.

McCune, Jenny. “10 Tricks to Keeping Your Cash Flow Healthy.” , 10 March 2000. Available from .

Mills, John, and Jeanne H. Yamamura. “The Power of Cash Flow Ratios.” Journal of Accountancy 186, no. 4 (1998): 53–57.

Priest, William W., and Lindsay H. McClelland. Free Cash Flow and Shareholder Yield: New Priorities for the Global Investor. Hoboken, NJ: John Wiley & Sons, 2007.

Silver, Jay. “Use of Cash Flow Projections.” Secured Lender, March/April 1997: 64–68.

Simon, Geoffrey A. “A Cash Flow Statement Says, ‘Show Me the Money!’” Tampa Bay Business Journal 27 (2001).

Tatum, Malcolm. “What is a Cash Budget?” WiseGeek, 14 December 2010. Available from .

Source Citation

Source Citation   

Gale Document Number: GALE|CX4016600046