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What is Cash Flow?


Consider a typical month or week in your business. How much money are you able to generate and use for expenses in this set time frame? The answer determines whether you have positive or negative cash flow.

Cash flow is the net amount of money moving into and out of your business over a given period of time. Cash comes into a business via customers who purchase products and services, while it flows out of a business via payments for operating expenses, rent or mortgage, loans, and taxes.

A cash flow statement reflects how money flows in and out of your business and can be generated monthly, quarterly, or annually. This type of summary tracks your business’s cash position and is used to assess liquidity and financial health.

Why is Cash Flow Important?

A positive cash flow must be achieved and maintained to keep a business running. As a small business owner, it is imperative that you learn to manage cash flow and understand when you will have cash on hand. This can be especially difficult for new businesses, as start-up expenses can quickly outpace customer sales.

Business owners cannot grow their business until cash flow is managed properly, which includes knowing how to increase on-hand cash in a short period of time and how to adjust spending to avoid future cash flow problems.

For small businesses that need to stabilize cash flow, a line of credit can help secure funds needed to keep a business running or pursue a particular initiative.

Cash Flow vs. Net Income

Net income is the amount a business earns after subtracting taxes, expenses, and other costs during a specific period of time. It is often referred to as the “bottom line” and it is used to determine profitability.

While cash flow refers to the cash or cash equivalents on hand, net income measures all transactions, whether they are in cash or not. Profits or losses originating from non-cash sources are factored into net income.

Cash Flow vs. Working Capital: What’s The Difference?

The key consideration in understanding the difference between working capital and cash flow involves assets and liabilities. Since the net profits for your business reflect your expenditures or liabilities against your income, a cash flow statement will never accurately reflect net profits. Essentially, the cash flow summary is a means of measuring and tracking how much money can be gathered from your business in any given time frame.

Unlike your expenses in a cash flow report, working capital takes into account how your outstanding debt compares to your current assets. For example, if you have a current loan of $10,000, you would expect to make payments on this loan as time goes on. However, an unforeseen decline in your customer base results in your inability to make payments, and the lender demands full repayment of the loan at the end of the month. The working capital allows you to see what debts can be resolved by liquidating your existing assets.

Obviously, this is an extreme scenario. In most cases, the working capital report is generated on a 12-month scale, and it takes into account all debts due within the next 12 months. The working capital report identifies what can be liquidated or sold to generate cash to pay down existing debts if your business experiences a sudden or gradual decline. This is a vital aspect of scalability. Unlike the cash flow report, working capital does not routinely include your planned monthly expenses that have not been paid for on loan or credit.

Understanding Cash Flow and How it Impacts Business Growth

Growing your business can be difficult. You must determine how much product your customers will need, how many staff members will be needed to ensure your customers are happy and satisfied, and what business processes will change to adapt to the new demand. Unfortunately, even well-planned businesses will sometimes experience a periodic decline in sales. This may be the result of economic instability, new competition, or unidentifiable factors.

When a decline occurs, how will you pay your bills in the meantime? You may be able to generate enough cash flow to scrape by if business picks up. However, if business does not pick up, can you liquidate your existing assets to cover your liabilities and debts? Now, consider how the expenses of growing your business play into asset and liability generation.

If you purchase new equipment, lease a new office space, or take out a loan to cover your expenses in the process of growth, you will incur a new liability. Regardless of how successful growing your business turned out to be, you owe this debt. Physical items, such as desks, computers, inventory, and proprietary information, can be liquidated to generate cash flow. As we’ve explained previously, you can minimize the risk of developing a negative working capital by growing in stages.

How to Calculate Cash Flow

Calculating a business’s cash flow is more complicated than subtracting expenses from income. There are several formulas you can use to gain a better understanding of your business’s overall financial performance.

Calculate Cash Flow from a Cash Flow Statement

The simplest way to determine cash flow is by adding or subtracting the differences in net income, expenses, and credit transactions as documented on a cash flow statement.

Total cash flow = Cash from operating activities +/- cash from investing activities +/- cash from financing activities + beginning cash balance

Calculating cash flow by creating a cash flow statement is a fundamental part of overseeing business finances.

Calculate Cash Flow from a Cash Flow Forecast

Cash flow forecasts can be used to predict cash flows or plan for future spending. If you’re wondering whether it’s a good time to make an investment, a cash flow forecast can inform your decision.

Cash flow forecast = Beginning cash balance + projected inflows – projected outflows 

If this formula does not predict a positive cash flow, it’s not a good time to add to your business expenses.

Calculate Operating Cash Flow

Operating cash flow refers to the amount of cash generated by the regular operating activities of a business. It is used to establish how much cash a business will have on hand to cover expenses during a given time period.

Operating cash flow = Net income + non-cash expenses – increases in working capital

If you’re looking to obtain outside funding from a bank or financial institution, they will probably want to know your operating cash flow.

Calculate Free Cash Flow

Free cash flow is the amount of cash a business has at its disposal after factoring in cash outflows such as operating expenses and capital expenditures. The remaining funds are free to use as the business chooses.

Free cash flow = Operating cash flow – capital expenditures

Free cash flow is a better indicator of profitability than net income because it indicates how much money is available to expand or reinvest in the business.

How to Increase Cash Flow

There are several ways to increase your liquidity and work toward a steady, positive cash flow. The first, which is also the most obvious, is to increase your revenue. This means you need to increase your number of customers, their buying frequency, and the amount of your average transaction. This may also mean raising prices.

Managing inventory and reducing overhead are two other options to improve cash flow. You don’t want to run out of inventory, but you also don’t want all of your money tied up in products that are sitting in a warehouse or storeroom. Finding that happy medium is the key to successful inventory management.

As for overhead, reducing your money spent on operating activities can grow your bottom line. You can achieve this by buying in bulk, finding more cost-effective vendors, outsourcing specific job roles, and finding a more economical business space.

Other ways to improve cash flow include paying off debts more quickly, enforcing shorter payment terms for your clients, and syncing up accounts receivable with accounts payable. If you’re in need of immediate cash flow, consider reviewing your options for small business loans.

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