As a small business owner, cash flow is king. What is cash flow? Cash flow is the money that moves in and out of your business bank account. Understanding where your cash is coming from and where it’s going is key for decision-making.
Think of cash flow like your car’s gas tank. You fill up the tank with gas, and it empties as you drive. The goal is to have enough gas in your tank so you never run on empty. This article will dive into how to define cash flow, how to analyze it, and how to read cash flow statements to help you better manage your business cash flow.
What is cash flow?
Cash flow is money coming into your business or going out. Cash inflow is the money you collect, while the definition of cash outflow is the money you’re spending. Net cash flow is the cash you have left after all the outflows.
Cash flow inflows and outflows appear on the cash flow statement as one of the following:
- Operating cash flow
- Financing cash flow
- Investing cash flow
Cash inflow vs cash outflow
Cash inflows can be physical cash or deposits that hit your bank account.
Cash inflows examples include:
- Customer payments
- Asset sales
- Proceeds from loans
Cash outflow is money you use, which means money leaving your bank account.
Typical cash outflows examples are:
- Credit card or debt payments
- Paying suppliers
- Buying inventory
Cash flow vs. profit
Your net cash flow from the cash flow statement is different from your net profit that shows up on the income statement.
Cash flow is the movement of money in or out of your bank accounts. Net cash flow is cash inflows minus cash outflows.
Net profit is revenue minus expenses. Some expenses affect your profit but are not cash flows, such as depreciation expenses. And vice versa. If you pay off a majority of your debt early, it’ll be a large cash outflow that lowers your cash balance. But your profit goes unaffected. This means that net cash flow will not always match net profit.
A cash flow statement uses cash basis accounting. An income statement uses accrual accounting. With cash basis accounting, you keep track of when cash exchanges hands. Accrual accounting records revenues and expenses when they occur.
For example, you pay for a two-year software subscription for $1,000 upfront. Your cash flow statement will show a $1,000 cash outflow on the day you paid. But the income statement breaks down the $1,000 as an expense over 24 months.
What is a cash flow statement?
The cash flow statement is the same as the statement of cash flows. It’s a record of cash paid or received by a business over a given period.
Small businesses should strive to be cash flow positive. What is positive cash flow and why do you need it? You want to generate more money than you’re spending. Being cash flow negative means your business is spending more cash than it’s bringing in. While being cash flow positive indicates you’re generating more cash than your cash outflows.
Positive cash flow helps make sure you can:
Pay bills
Buy equipment and inventory
Invest in new growth opportunities
Repay debt
The 3 types of cash flow
There are three key types of cash flow sections on the cash flow statement—the operating, investing, and financing cash flows. The type of cash flow will depend on where you get the money, or what you spend it on.
Operating cash flow
Operating cash flow is the same as cash flow from operations. It includes cash from core business activities that involve the sale or production of your goods or services. Examples include customer payments, payroll, and inventory purchases.
To calculate your operating cash flow, you’ll need your net income. You’ll also need any noncash expenses like depreciation and changes in working capital.
Operating cash flow = Net income + non-cash items + working capital changes
Working capital is your current assets, less your current liabilities. This formula adjusts the accrual accounting items—accounts receivable, accounts payable, and inventory—to a cash basis.
Investing cash flow
Investing cash flow is money you spend on fixed assets like equipment. It can also be cash you bring in from selling equipment.
Fixed assets are assets you plan to use for a long time, such as a vehicle or machinery. Buying equipment is an investing cash outflow. Selling some of your fixed assets would be an inflow.
Financing cash flow
Financing cash flow is the money you pay or receive from lenders, investors, or other creditors. Any cash flows related to debt or equity fall into this category. If you took out a loan, that’d be an inflow. But repaying debt or paying dividends are outflows.
How to read a cash flow statement
Cash flow statements provide valuable insights into a company’s finances. But business owners aren’t always sure how they connect.
Each accounting statement can help you understand your company’s performance. The balance sheet and cash flow statement focus on financial management. The income statement shows you the core operating activities generating the most income.
Your cash flow statement should start with your beginning cash balance. Then, add the net cash flow from each of the three cash flow categories.
The ending number should match the cash balance on your balance sheet. Net cash flow over the period for your balance sheet is the sum of all three types of cash flow.
Net cash flow = operating cash flow + investing cash flow + financing cash flow
The operating cash flow section will be the largest section for most businesses. If your business doesn’t have many fixed assets, the investing section will be minimal. Businesses with loans or shareholders will have some activity in their financing section.
Cash flow analysis
Cash flow issues arise when business owners misinterpret profit as cash flow. It’s easy to think that the key to positive cash flow is more sales, but that’s not always the case.
1. Create a cash flow statement
Creating a cash flow statement is easy to generate.
2. Analyze your cash flows
The second step involves looking at your cash flow and identifying trends. Make sure there’s more money coming in than going out, but look for ways to improve those inflows.
Free cash flow is a helpful metric for analyzing cash flows. It’s the operating cash flow a company generates minus capital expenditures.
3. Set cash flow goals
Now that you know the major issues, you can address them a bit easier. That means making sure your cash flow aligns with your near-term goals.
These goals can include reducing the time it takes to collect money from customers. Or bringing in additional cash by selling unused assets.
5 tips for cash flow management
Small businesses can manage cash flow better if they know how to calculate it and what to focus on.
Practice calculating it yourself
The best way to understand the definition of cash flow in business is to practice calculating it. Here are the steps to get you started:
Identify the period you plan to analyze
Adjust net income for non-cash items and working capital changes
Add or subtract cash payments for investing and financing activities
Focus on cash flow management, not profits
Profits and cash flow aren’t the same. You can be profitable on the income statement but have negative cash flow. It’s best to focus on managing cash flow, which will determine your ability to pay bills and grow your business.
One tip for boosting cash flow is to get a percentage of a contract or large order upfront.
Keep some cash on hand
Cash is king for paying short-term bills or addressing emergencies. As a business owner, you can’t expect every speed bump. But it does help to have a rainy-day fund to pay for any unforeseen expenses.
A good rule of thumb for business emergency funds is to have enough to cover a month or two of expenses.
Collect cash sooner
QuickBooks found that 89% of small businesses experience growth setbacks due to late customer payments. Getting money in your hands sooner is an easy way to boost cash flow. If your business invoices customers, you have to wait to get your money. Encourage them to pay sooner by offering discounts to those that pay before the due date.
For example, you can offer a 2% discount if you get the payment within 10 days of invoicing. Controlling your accounts receivables is one of the best ways to get customers to pay faster.
Project cash flow
A cash flow analysis helps assess current cash flows. But cash flow projections give you a look at future cash flows. Estimating what your cash flow will be in the near term allows you to make adjustments now. And before they become major issues.
Related:
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- How to start an e-commerce business and succeed in 2023
This article originally appeared on the Quickbooks Resource Center and was syndicated by MediaFeed.org.
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