Top Cash Flow Analysis Methods

Top Cash Flow Analysis Methods

Find out which cash flow analysis method is right for your financial planning needs.

No matter if you’re managing a personal household budget, a business, or both, understanding how to properly manage and analyze cash flow is essential to maintaining financial stability.

Accurate cash flow analyses translate to financial security. They ensure the money you have coming in is sufficient to cover expenses, save, invest, and spend on specific goals.

However, cash flow analysis isn’t limited to inflows versus outflows: It also provides you with a comprehensive spending picture that you can use to optimize your financial health, plan for emergencies, and cut back on unnecessary expenses. 

That’s why, in this article, we’ll explore some of the most popular cash flow analysis methods.

Let’s start with one of the more straightforward methods of cash flow analysis: the direct cash flow method.

1. Direct Cash Flow Method

The direct cash flow method is the most straightforward, so it’s usually the most beneficial for individuals or businesses that want a clear view of their finances. 

This method involves tracking all cash transactions as they happen—every dollar that comes in and goes out.

For homeowners, this method could be as simple as tracking your paycheck deposits, mortgage payments, utility bills, and grocery expenses. 

For professionals and business owners, it’s about recording every cash receipt from sales and every cash payment for supplies, salaries, rent, and other business expenses.

Benefits of the direct cash flow method include:

• A clear picture of your cash inflows and outflows;
• Fast identification of poor spending and negative cash flow;
• A detailed and up-to-date understanding of your cash position; and
• An ideal tool for quickly managing short-term liquidity to cover large upcoming expenses.

Next, let’s look at one of the more popular methods used by larger businesses: The indirect cash flow method.

2. Indirect Cash Flow Method

Larger businesses commonly use the indirect cash flow method, which is often found in financial statements. 

This method starts with net income from the income statement and then adjusts for non-cash transactions (like depreciation) and any changes in working capital.

Ultimately, the indirect cash flow method is a more complex way of understanding how non-cash items impact your overall financial health. For example, if you own a rental property, this method would help you identify how depreciation on that property affects your cash flow, even if it’s not immediately apparent in your bank account.

Benefits of the indirect cash flow method include:

• A more comprehensive overview of your financial health that incorporates non-cash factors;
• An understanding of how your operating, investing, and financing activities contribute to overall cash flow;
• A useful preparation tool for tax or long-term financial planning; and
• A useful aid for considering how the purchase of new assets and investments may impact your overall liquidity.

Next up is the operating cash flow analysis, a technique that approaches cash flow planning a little differently than our previous two methods thus far.

3. Operating Cash Flow (OCF) Analysis

Operating cash flow (OCF) is an analysis that shows how much cash is generated by operating activities—in other words, how much cash you have after covering the day-to-day costs of living or running your business.

For example, if you’re a homeowner with a side business, an OCF analysis would show you how much cash you have remaining after covering business expenses, such as supplies, rent, and payroll. The higher your OCF, the more cash you have to reinvest in your business, pay down debt, or save for future needs.

Some benefits of the OCF method include: 

• A focus on cash generated from core operations, excluding investment or financing activities;
• A clear picture of your ability to sustain operations and cover necessary expenses;
• A useful tool for determining how much money is available to reinvest in your business; and
• A clear picture of how much cash you have to pay down debts.

Then, there’s the free cash flow (FCF) analysis.

4. Free Cash Flow (FCF) Analysis

Free cash flow (FCF) analyses illustrate how much cash is available after a business or individual has paid for its capital expenditures. 

In other words, it shows you how much cash you have left over after you’ve paid for everything you need to maintain your operations, such as repairing equipment or making home improvements.

For homeowners, FCF analyses might be the cash remaining after paying for necessary home repairs, utilities, and other essential expenses. For professionals, it could be the money left after investing in business growth, such as buying new equipment or expanding operations.

Some benefits of the FCF analysis method include:

• A clear picture of how much money you have available for savings, investments, or other financial goals;
• A clear indication of your financial health by illustrating how much liquidity you have left over to spend;
• An ideal guide for making major financial decisions, such as investing in new projects or saving for retirement; and
• An aid for helping you assess your ability to fund future growth or weather financial downturns.

Finally, cash flow forecasting enters the game as another cash flow analysis method that focuses on the future.

5. Cash Flow Forecasting

Cash flow forecasting is a proactive way to predict future cash flows based on historical data, expected revenues, and anticipated expenses. 

Forecasting helps you anticipate when you might face a cash crunch and when you might have a surplus.

Homeowners can use this method to plan for significant upcoming expenses, like a vacation or a new car purchase, by forecasting when they’ll have the cash available. 

Business professionals can use it to plan for future investments or to ensure they have enough cash to cover operational costs during slower periods.

The benefits of cash flow forecasting include:

• The ability to anticipate cash flow issues before they arise;
• A tool to help you align your financial activities with your short-term and long-term goals; and
• A useful aid for planning for significant expenses or investments.

Ultimately, knowing which cash flow analysis method to use for your specific situation starts with consulting the right financial professional.

Get Your Cash Flow Right With Help From Avior

Understanding and applying these cash flow analysis methods empowers you to make smarter financial decisions. Take control of your financial health and ensure you have the cash you need, when you need it. 

The team at Avior is here to help you with cash flow planning. We’ll show you how the decisions you make now impact your financial future. We take the time to learn what’s most important to you and your family, so we can create a financial plan together that achieves your goals.

Talk to the team at Avior today to get started with an advisor.

Disclaimer: Nothing contained herein should be construed as legal or tax advice. Avior and our Advisors will work with your attorney and/or tax professional to assist with your legal and tax strategies. Please consult your attorney or tax professional with specific legal and/or tax questions. Investment Management and Financial Planner are offered through Avior Wealth Management, LLC, an SEC-registered investment advisor. Past performance is not a guarantee of future results.  Investments are subject to loss, including the loss of principal.