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CASH FLOW ANALYSIS is used by a lender to evaluate the ability of a business to repay debt with a comfortable margin. There are two primary types of cash flow a lender may analyze in order to determine this figure, and a lender may use either or both types to perform its analysis.

The first type is traditional cash flow. Traditional cash flow is calculated from the annual profit and loss statement using the following formula:

An example of a non-recurring expense would be rent if the business were moving from a leased space to an owner occupied space. The resulting traditional cash flow figure is also commonly referred to as earnings before interest, taxes, depreciation and amortization (or EBITDA) plus other non-cash expense items and any non-recurring expenses.

The other type of cash flow analyzed by lenders is actual cash flow. Actual cash flow is determined through utilizing a business’ Statement of Cash Flows and the line item known as “Cash Flow from Operating Activities.” However, in a large number of instances a Statement of Cash Flows is not prepared by a small business’ controller or CPA. Therefore, many lenders utilize the balance sheet and profit and loss statements of a business to build a Statement of Cash Flows and calculate “Cash Flow from Operating Activities.” Besides normal profit and loss items that affect cash flow, balance sheet items may affect this calculation. This can include items such as changes in inventory levels, accounts receivables, accounts payables, etc. As with traditional cash flow, certain adjustments are also made to “Cash Flow from Operating Activities” including adding back:

In some cases, a lender may also subtract provisions for additional items from traditional and actual cash flow figures. These may include items such as owner/outside party management fees; capital expenditure reserves; and furniture, fixtures and equipment replacement reserves. The amount and type of additional provisions subtracted from cash flow are typically a function of the type of business being financed.