Key takeaways:

• Optimizing your cash flow can improve your chances of getting a business loan. This includes maintaining up-to-date financial records, demonstrating revenue from multiple sources, and applying for financing proactively.
• Regular cash flow analysis helps small business owners track financial health, make smarter decisions, and spot problems early. 
• When you apply for a small business loan, banks and other lenders often analyze cash flow. They look for consistency, positive trends, and your ability to cover debt payments.
• A good cash flow ratio (like the operating cash flow ratio) can indicate your business’s financial health. 

Cash flow management makes or breaks a lot of businesses. Being able to pay your expenses from the revenue coming into your business is essential if your business wants to survive in the long run.

For many small business owners, though, financial statements can be intimidating. Balance sheets, income statements, and cash flow statements may seem overwhelming at first. Believe it or not, the more time you spend with them, the more you will understand them. 

And that’s important because having a good understanding of your business financial statements can be extremely helpful both to better manage your business operations and to plan for growth. Financial analysis can help you understand things like the financial health of your business, what business activities are working, where to double down or cut back, and much more. 

Here we’ll explain how banks and other small business lenders may use cash flow analysis when considering business financing applications, and help you learn how to optimize your business cash flow for financing and growth.

Why Is Cash Flow Analysis Important?

Cash flow analysis is a key tool for managing your small business finances. It helps you understand how money moves in and out of your business over time. It’s an essential companion to business budgeting. 

Here’s why it matters:

Track your financial health: Cash flow analysis shows if you have enough money to cover your expenses. It’s like taking your business’s financial pulse. If you want a healthy business, you need to know the amount of cash you have on hand, and how much you will need to meet future financial obligations.

Make smarter decisions: By understanding your cash flow, you can plan better. You’ll know when you can afford to invest in new equipment or when you need to cut costs.

Spot problems early: Regular cash flow checks can help you see issues before they become major problems. For example, you might notice that certain customers always pay late and you can use that to develop a better credit policy. 

Plan for growth: Cash flow analysis helps you see if you’re ready to expand. It shows if you have the funds to hire new staff, open a new location, or add new products or services.

Prepare for slow periods: Most businesses have busy and slow seasons. Cash flow analysis helps you save during good times to cover expenses during lean months.

Get financing: Lenders often want to see your cash flow statements. Good cash flow can make it easier to get loans or credit when you need them.

By keeping a close eye on your cash flow, you’re more likely to build a stable, growing business. It might take some practice, but understanding your cash flow is a skill that pays off.

How Do You Forecast Cash Flow for a Business?

Forecasting cash flow helps you predict your business’s financial future. It’s a valuable tool for planning and avoiding cash shortages. Here’s how to forecast cash flow for your business:

Start with your current cash position. This is the amount of money you have on hand right now.

Estimate your future cash inflows. Think about:

• Expected sales and when customers will pay
• Any other income sources, like investments or grants

Predict your cash outflows. Consider:

• Regular expenses like rent, utilities, and payroll
• Planned purchases or investments
• Loan payments or other debts

Create a timeline. Most businesses forecast monthly, but you might need weekly or even daily forecasts during tight times.

Use past data as a guide. Look at your previous years’ patterns to help predict future cash flow.

Be realistic. It’s better to underestimate income and overestimate expenses than the other way around.

Update regularly. Cash flow forecasts aren’t set in stone. Review and adjust your forecast as you get new information.

Consider different scenarios. Create best-case and worst-case forecasts to help you prepare for various outcomes.

Use tools to help. Many accounting software programs have cash flow forecasting features. These can save time and reduce errors.

Remember, cash flow forecasting is a skill that improves with practice. The more you do it, the better you’ll become at predicting your business’s financial future.

What is the Formula for Cash Flow Analysis?

A cash flow statement, sometimes called a statement of cash flows, is especially important as it helps you understand how cash and cash equivalents have moved through your business throughout the year (or a specific accounting period), and your ending cash position. Cash equivalents can be quickly converted to cash, usually within three months. 

At its most basic method, cash flow statement analysis compares cash received with cash paid out. Cash received includes sales revenues as well as investment or interest income. Cash paid out can include any number of items including inventory, taxes, payroll, loan payments, etc. 

Just taking a simple approach can be helpful. But if you really want to understand your business cash flow you’ll discover there are more detailed ways to analyze it. 

Operating cash flow can help you understand whether your business has sufficient cash flow to maintain operations, without having to seek additional funding or financing. There are two ways to calculate operating cash flow: the direct method and the indirect method. 

The direct method is used by businesses using cash basis accounting. Here, cash inflows and cash outflows are all that is measured. 

The indirect method is used by companies that use accrual basis accounting and includes non-cash transactions as well as cash transactions. 

You may also want to analyze free cash flow, which indicates the money available to the business after operating expenses and capital expenditures have been paid. 

Note that whatever method you use,  you have to start with good data. That means you need to make sure your bookkeeping is up to date.

What if you haven’t started your business yet? Cash flow projections can help you plan your anticipated cash flow for your business. Even if you have to make some educated guesses, this can help you anticipate what your business needs.

Cash Flow Statement Walk Thru

There are generally four main components to a cash flow statement:

• Cash flow from operating activities
• Cash flow from financing activities
• Cash flow from investing activities
• Net change in cash balance

These categories each contain important sets of information. 

Cash flow from operations includes net income, depreciation, amortization, changes in accounts receivable, changes in accounts payable, taxes payable, changes in inventory, wages, and items of that nature. 

Financing activities encompasses those used to finance your business. This can include notes payable, lines of credit, long-term debt, and short-term debt. Payments on a small business loan or business credit card repayment would be included in this section.

The third main category, investing activities, consists of capital expenditures, paying dividends, and other activities of a similar nature.

The pertinent numbers in each section allow you to see which ones have had positive or negative cash flows. These sections are then totaled so that you can quickly ascertain the net cash flow from all activities over a given period of time.

What Is a Good Cash Flow Ratio for a Business?

Cash flow ratios can help you track and measure your business’s ability to meet its short-term obligations and maintain healthy financial operations. While there’s no one-size-fits-all “good” ratio, understanding these numbers can help you guide your decisions, measure your progress, and benchmark against other businesses.

One of the most widely used ratios is the operating cash flow ratio, which provides insight into your ability to cover short-term obligations. Here’s how it works:

Operating Cash Flow Ratio = Operating Cash Flow / Current Liabilities

This ratio shows if your business generates enough cash to cover short-term debts. A ratio above 1 means you’re bringing in more cash than you need to pay current debts. That’s generally good.

Here’s what different ratios might mean:

• Below 1: Your business might struggle to pay short-term debts without outside help.
• 1 to 1.5: You can cover your debts, but there’s not much room for unexpected expenses.
• Above 1.5: Your business likely has a healthy cash flow and can handle some financial surprises.

Remember, these are general guidelines. However, what’s considered ‘good’ can vary significantly depending on your industry, business model, and the size of your business. 

For example, newer businesses might experience a lower ratio while investing in growth and expansion.

Here are some ways to put this into context:

• Compare your ratio to similar businesses in your industry. Industry-specific benchmarks can provide a more accurate understanding of how your business is performing compared to others.
• Look at how your ratio changes over time. Tracking trends is crucial to understanding whether your business is improving or facing potential cash flow challenges.
• Consider your business goals and growth plans. Your cash flow needs will evolve as your business grows. What’s good in the early stages may not work as well later, so make sure you also focus on long-term objectives.

While ratios are helpful, they’re just one part of understanding the financial health of your business. Use them alongside other tools like your income statement and balance sheet for a full picture.

If you’re unsure about calculating or interpreting your cash flow ratio, talking to a business mentor, business coach, or accountant can help. They can provide personalized advice for your business, and answer questions about your specific business. 

What Is an Example of Cash Flow Analysis?

Here’s an example of cash flow analysis for a hair salon:

Starting cash: $3,000

Cash coming in:

• Haircuts and styling: $12,000
• Color treatments: $8,000
• Product sales: $2,500 

Total cash in: $22,500

Cash going out:

• Stylist wages: $9,000
• Rent: $2,500
• Utilities: $800
• Hair products and supplies: $3,500
• Loan payment: $1,000
• Marketing: $500 

Total cash out: $17,300

Ending cash: $8,200

In this example, the salon started with $3,000 and ended with a cash position of $8,200. 

What this tells us:

1. The salon brought in more money than it spent, which is positive.
2. Haircuts, styling, and color treatments were the main sources of income.
3. Stylist wages and hair products were the biggest expenses.

This analysis helps the salon owner understand that:

• They have enough cash to cover expenses and some left over.
• There might be an opportunity to expand services or invest in new equipment.
• They could (and should) set aside some money for future slow periods or unexpected expenses.

By reviewing this regularly, the salon owner can:

• Track which services are most profitable
• Plan for busy and slow seasons
• Make informed decisions about hiring or offering new services
• Ensure they always have enough cash for supplies and payroll

This simple analysis gives the salon owner a clear picture of their business’s financial health and helps guide future decisions.

What Do Banks Want to Know About Your Cash Flow?

When you apply for a business loan, banks and other companies that offer small business financing often look at your cash flow in one form or another. They want to make sure you can repay the loan or financing. 

To understand your business cash flow, they may ask for:

• Business bank account statements
• Business financial statements and/or
• A business plan 

Here are some of the major factors related to cash flow they look at: 

Consistency and stability: They like to see steady, predictable revenue and cash flow.  This shows your business is stable. A recent decline in revenue, or a large increase in expenses (and a declining business bank account balance) can signal the business is experiencing financial challenges. 

Positive trends: They look for increasing cash flow over time. This suggests your business is growing. Recent declines in revenue or cash flow may disqualify the business, or result in higher cost financing. 

Debt coverage: Banks often calculate if you have enough cash to cover loan payments plus your other expenses using a debt service coverage ratio (DSCR). 

Seasonality: If your business has busy and slow seasons, lenders want to make sure your business can manage cash flow during the down season.

Sources of cash: They may look at the types of cash flow, and specifically whether revenue comes from multiple sources, as well as whether cash flow comes mainly from sales or from loans.

Use of cash: Some banks will drill into how the business spends its money. If most of the cash is going to owner compensation rather than investing cash for growth, they may hesitate to lend more.

Cash flow projections: Not all lenders will require cash flow projections, but those that do will assess your business plans and ability to repay new financing.

Cash reserves: Having a cash cushion shows you can handle unexpected expenses or slowdowns.

Accounts receivable and payable: Some lenders may review an Accounts Receivable Aging Report to see how quickly you collect payments and pay your bills.

Want to be ready for financing?

If you don’t need business financing now, there’s a strong chance you will at some point. The single most important things you can do to prepare for getting a small business loan in the future are:

1. Use a business checking account. All business income and expenses should flow through that bank account. Don’t pay personal expenses from this account. This will make it easy for lenders to quickly assess your business cash flow.
2. Keep your bookkeeping up to date. This will allow you to create financial statements easily if needed. (It also makes it a lot easier to prepare income tax returns.) 

Other things you can do to prepare for a traditional small business loan (such a bank loan or SBA loan) in particular: 

• Be prepared to explain any large changes in your cash flow.
• Have a clear plan for how you’ll use the funds and repay the loan.

Remember, banks and other companies that offer small business financing use cash flow information to assess risk. The stronger and more stable your cash flow, the more likely you are to get approved for a loan or financing with good terms.

Uncovering Opportunities With A Cash Flow Analysis

Opportunities go both ways when it comes to looking at cash flow analysis. Positive cash flow is generally a positive sign. It is showing you that you have more money coming in than going out which, at a glance, is good. However, you may still have room for improvement to grow your business, pay off debts, or upgrade equipment. If you’ve just been focused on maintaining positive cash flow, you may have failed to take advantage of these opportunities. 

Negative cash flow can be just as it sounds— negative— but sometimes it’s indicative of growth. While negative cash flow can definitely indicate a business is struggling financially, isn’t profitable, or has overstretched itself, it can also accompany a period of growth. It can indicate that a company is hiring more employees, investing in equipment, inventory or advertising, for example.

Ultimately determining that a company’s cash flow is negative or even positive shouldn’t be the beginning or the end of an evaluation of the health of the business. Rather the statement as a whole should be looked at and it should be a starting point to understand the business journey. 

Optimize Your Cash Flow For Business Loans

Even though it may be normal for a business to experience negative cash flow for a period of time, understand that it can hamper your ability to get a small business loan or financing. 

Some lenders may be willing to lend if your business has strong revenues, and the ability to make payments on a future loan. Many lenders will want to review 3-6 months of business bank statements.

You may have more financing options if you have good credit (personal and/or business credit scores) and are willing to provide a personal guarantee. 

It’s also helpful to demonstrate revenue from multiple sources. If your business is too dependent on one client, or a single product, it will be considered more risky. 

Collateral can be helpful for some types of loans.

Ideally, you want to try to plan ahead. While you may not feel like you need financing when you have a healthy amount of money in your business bank account, that may be the best time to apply for a line of credit or other types of financing you anticipate needing in the future. It’s best to apply for small business financing before you are in desperate need of cash for working capital.

How Nav Can Help

Nav Cash Flow Health makes it easy to monitor and manage your cash flow across all your accounts. Balance forecasting gives you an easy way to monitor your overall performance and make changes. And real-time alerts tell you when your balance falls below set limits, and more. It’s a simple way to start tracking your cash flow, and building a financially healthy business.