Cash Flow Analysis And Statement 140
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Cash flow analysis is a method of analyzing the financing, investing, and operating activities of a company. The primary 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. Since 1988, the Securities and Exchange Commission (SEC) has required every company that files reports to include a cash flow statement with its quarterly and annual reports. The cash flow statement is useful to managers, lenders, and investors because it translates the earnings reported on the income statement—which are subject to reporting regulations and accounting decisions—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," Harry Domash notes on his Web site, "Unlike reported earnings, there is little a company can do to overstate its bank balance."


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 collections of cash proceeds from secured bank loans (or issuances of stock, or transfers of personal assets to the company) is typically not considered a recurring activity. Similarly, cash payments to vendors is a recurring activity, whereas repayments of secured bank loans (or 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 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 twelve 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 is 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, and/or increase dividends. If the calculated amount of free cash flow is negative, this amount represents the amount of cash that must be borrowed (and/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 balances 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).


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 (i.e., intracompany comparisons) as well as comparisons of other companies (i.e., intercompany or industry comparisons). While ratio analysis may be used in conjunction with the cash flow statement and/or the cash budget, 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 embarrassment. For example, it helps avoid having to lie that the check is in the mail.
  2. A firm that understands its cash position can borrow exactly what it needs and no more, there by 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 analyses deter 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 several months from now, the firm can turn down the first two offers of terms and have time for further negotiations.


Potential borrowers should be prepared to answer the following questions when applying for loans:

  1. How much cash is needed?
  2. How will this cash help the business (i.e., how does the loan help the business accomplish its business objectives as documented in the business plan)?
  3. How will the company pay back the cash?
  4. How will the company pay back the cash if the company goes bankrupt?
  5. How much do the major stakeholders have invested in the company?

Admittedly, it is in the best interest of the potential borrower to address these questions prior to requesting a loan. Accordingly, in addition to having a well-prepared cash flow analysis, the potential borrower should prepare a separate document addressing the following information:

  1. Details of the assumptions underpinning the specific amount needed should be prepared (with cross-references to relevant information included in the cash flow analysis).
  2. The logic underlying the business need for the amount of cash requested should be clearly stated (and cross-referenced to the relevant objectives stated in the business plan or some other strategic planning document).
  3. The company should clearly state what potential assets would be available to satisfy the claims of the lender in case of default (i.e., the company should indicate the assets available for the collateralization of the loan).
  4. Details of the equity interests of major stakeholders should be stated.

In some cases, the lender may also request personal guarantees of loan repayment. If this is necessary, the document will need to include relevant information regarding the personal assets of the major stakeholders available to satisfy the claims of the lender in case of default.


Many businesses fail due to inadequate capitalization. Inadequate capitalization basically implies that there were not enough cash and/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, and potential lenders. Additional information can be solicited from potential customers, vendors, and competitors, allowing the firm to learn from others's 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 their cash flow. 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 the unconstrained growth.


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's claims. Significantly, not all bankruptcies are fatal. In some circumstances, creditors may allow the bankrupt company to reorganize its financial affairs, allowing the company 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 can not compensate for poor management, poor products, or weak internal controls.

SEE ALSO: Budgeting ; Financial Issues for Managers ; Financial Ratios ; Strategic Planning Tools

Michael S. Luehlfing

Revised by Laurie Hillstrom


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

Domash, Harry. "Check Cash Flow First." Available from .

"Intro to 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.

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

"Preparing Your Cash Flow Statement." U.S. Small Business Administration, Online Women's Business Center. Available from

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).

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