When you review your business numbers, you’re spending time on three key financial statements: the profit and loss statement (also known as P&L or income statement), balance sheet, and cash flow statement. These three statements give you the complete picture of your business from a financial perspective and tell you exactly how your business is doing.
Reviewing your actual results tells you what has happened in your business in the past. But, the real power of these statements comes when you analyze them in comparison to what you had planned and what your future goals are. When you do this, you’ll know if your business is on track to meet its goals or if it’s falling short and you need to change your strategy.
What is a cash flow analysis?
Comparing your plan to your actual results for your P&L and balance sheet is pretty straightforward. But, doing a cash flow analysis—that is, reviewing your cash flow statement—can be a bit more confusing.
That’s because the cash flow statement is, for the most part, recording changes to different areas of your business rather than absolute numbers. For a rundown of how your cash flow statement works and an explanation of each row, check out our detailed explanation.
Why the cash flow statement is important
From an accounting standpoint, your business may look profitable. However, without knowing how much cash you have on hand, tracking outstanding expenses, and other risk factors, that profitability can quickly disappear. That’s why reviewing your cash flow statement is so crucial, as it’s meant to help you understand the health of your business.
How do you analyze cash flow?
Even if you fully understand how to read your cash flow statement, you probably still have a few questions that you’ll want to be able to answer as part of the monthly financial review of your business. Here are the five most common questions and explanations so you can understand what to look for when you’re performing a cash flow analysis that includes comparing your plan to your actual results.
1. Profits are up, so why don’t I have more cash in the bank?
This is probably the most common question businesses have. Sales have been great and you’ve been keeping to your expense budget. This has led to some solid profits, but your “net change in cash” (the amount of cash generated that your business added to its bank account) isn’t as much as you’d hoped. How can this be?
Profits and cash aren’t the same thing
The simple answer is because profits and cash are different things. Just because you made sales doesn’t mean that your customers actually paid you. If you’re like most businesses and you invoice your customers, they may take some time to pay you.
To see if this is the case, you’ll want to look at your “change in accounts receivable” line of your cash flow. If this number is low, or even negative, this means that your customers haven’t paid you very much even though you’ve booked the sales already.
You paid your bills or had a change in accounts payable
When you pay your bills can also impact your cash situation. If you paid more bills than you originally planned, this will reduce your cash.
Look to your “change in accounts payable” line of your cash flow to see. If the number here is more than you planned, then you paid more bills than you had planned to pay. This could be O.K. because you don’t want to build up a lot of unpaid bills, but could easily be the source of your reduced cash.
Some of your cash is tied up in inventory
You should also take a look at your “change in inventory” line of your cash flow statement to see if that’s where your cash went. If the number is lower than expected, it could be because you needed to purchase more inventory to support your increased sales. The number could even be negative if you purchased more inventory than you sold.
This could be a good thing in the big picture for your business and might explain where your cash is going.
2. Is a negative change in accounts receivable a good thing?
There’s, unfortunately, no right answer to this question. The real answer is “it depends.” First, let’s look at what a negative number in “change in accounts receivable” means.
A negative number means that customers owe you more money and haven’t paid you yet. So, what could have caused this increase in outstanding invoices to occur? Well, there are likely two reasons.
Your sales increased
One reason this number might be negative is because of increased sales. If your sales increased more than planned, you sent out more invoices and your customers just haven’t paid you yet. You’ll want these customers to pay eventually, of course.
You’re not collecting fast enough
Another reason the number may not be as high as you want it to be is that you’re not collecting from your customers fast enough. You may need to chase down delinquent customers and make sure they pay their invoices.
Either way, you’ll want to make sure you have enough cash in the bank to wait it out while you wait for customers to pay you. That’s why you’ll not only want to compare your actual results to your plan but revise your plan so that you have an accurate cash flow forecast moving forward.
3. Should I be concerned about a larger than planned change in accounts payable?
Again, the answer here is “it depends.” A larger than planned number in “change in accounts payable” means that you are collecting bills that you need to pay eventually and just aren’t paying them yet.
Maybe this is O.K. and you don’t need to pay your bills yet. But, you don’t want to be delinquent in your payments either. If you’re short on cash, delaying some payments may be a good idea. But, you’ll want to keep an eye on this number and make sure it doesn’t continue to be significantly more than you planned.
4. What does a larger change in inventory mean for my business?
If you have a positive number in the “change in inventory” line of your cash flow, that means that you’ve sold more products to your customers than you’ve bought from your suppliers during the month. Conversely, if the number is negative, you’ve purchased more inventory from your suppliers than you’ve sold to customers.
Neither situation is “bad” for your business—it really depends on how much inventory you like to keep on hand and how frequently you purchase inventory. If you own a bike shop, for example, you may only purchase new inventory a few times a year. If you own a grocery store, you’re likely purchasing new inventory several times a week.
So, if “change in inventory” is a larger (more positive) number than you had planned, you’ve sold more product than you’ve purchased and you may need to order more inventory soon.
If “change in inventory” is smaller (more negative) than you had planned, you’ve purchased more inventory than you’ve sold and maybe you need to focus more on sales before buying more inventory.
5. What if the net change in cash isn’t as positive as planned?
The “net change in cash” line of your cash flow totals up all of the cash inflows and outflows in your business. It’s essentially the amount of cash that you’re either adding to (or subtracting from) your bank account. If the number is positive, more cash balance has grown during the month. If the number is negative, you’re ending the month with less cash than you started with.
If the number is not as positive as you had hoped, there are a few places to start looking.
First, maybe your customers aren’t paying you as fast as you had hoped. If your “change in accounts receivable” line is negative, this is a good indicator that you’re owed some money. Check your balance sheet to see exactly how much you are owed.
Second, check your accounts payable. Maybe you’re paying bills faster than planned and you should slow down. Again, refer to your balance sheet to see if your accounts payable balance is lower than expected.
Third, check your inventory. If you made extra inventory purchases, this can certainly impact your cash position.
Sales and expenses
Of course, you should also be looking at your overall sales and expenses. If you’re on track with sales and expenses, then looking at the three issues outlined above is the best place to start. If you’re off track with sales or expenses, that will also impact your cash position.
Use your cash flow analysis to guide tactical and strategic shifts
Overall, reviewing your cash flow statement and comparing your plan to your actual results will tell you how cash is moving into and out of your business. And, most importantly, it will give you clues as to where to look to make changes in your business if things aren’t going quite as planned.
When you’ve finished your cash flow analysis, you now have an opportunity to make strategic changes to your business. Your analysis should produce a task list of improvements you want to make to your business. Perhaps you need to negotiate better payment terms with your vendors or figure out how you can make your customers pay you faster. You might want to re-think when you reorder inventory and the size of those orders.
If the time you spend reviewing your financials and comparing your plan to your actual results yields actionable ideas to improve your business, you’re managing your business smartly for growth.
Editor’s note: This article was originally published in 2019 and updated for 2021.