The Beginner’s Guide to Cash Flow

by John Kuo

5 min read

Cash flow is the movement of cash in and out of your business. Cash inflows are your sources of income and cash outflows are your expenses.

Let’s say you own a donut shop. When customers buy donuts, the money they pay for the donuts generates a cash inflow. However, when you buy flour and other ingredients for your donuts, you are creating a cash outflow.

For small businesses, positive cash flow is the goal. You want to generate more money than you’re spending. This sounds simple, but plenty of profitable businesses run into cash flow problems. It can be challenging to balance regular expenses like salaries, rent and technology with irregular revenue. Many businesses will go through periods of negative cash flow because of seasonality or because they are investing in growth.

Achieving positive cash flow is one of the most impressive accomplishments in small business. Companies typically report their cash flow through on a cash flow statement.

What Is a Cash Flow Statement?

A cash flow statement—also known as statement of cash flows—tracks money in and money out. It will show how much cash a company has on hand and provide insight on a company’s liquidity. Public companies are required to release cash flow statements each quarter. You can see examples, like Nordstrom, Apple and Ford on Yahoo! Finance.

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Cash flow statements, along with balance sheets and income statements help provide insights on a company’s finances. So how do they all work together?

The balance sheet gives you an overall view of a company’s finances. It is split into assets, liabilities and equity. The cash balance from a company’s cash flow statement appears in the balance sheet. The income statement shows a company’s revenue, expenses, and profit and losses. It will offer insights on a company’s profitability.

The Difference Between Cash Flow and Profit

Although cash flow and profit are related, they’re quite different when it comes to accounting. You can see it most clearly when you compare an income statement to a cash flow statement.

The biggest difference between the two that the income statement is based on accrual accounting, whereas the cash flow statement is based on cash basis accounting. With cash basis accounting, you keep track of when cash is exchanged. Accrual accounting, on the other hand, records revenues and expenses when they occur. For example, if you paid for a two-year newspaper subscription for $240 up front, your cash flow statement will show $240 immediately, whereas your income statement will break the $240 down into each individual accounting period.

After starting Storyhackers, a content consultancy, Ritika Puri ran into cash flow issues even though her business was profitable. As a consultancy, they relied on invoices to collect payments from customers. As anyone who sends invoices knows, customers don’t always pay on time. Even though Storyhackers was profitable according to their income statement, they were short on cash.

“[T]here we were, with the best intentions, failing to make our payment deadlines simply because I could not manage our cash flow,” Ritika recently wrote on the Quickbooks blog.

The relationship between cash flow and profit will vary depending on the type of business. Some businesses will see their cash inflows fluctuate as a result of seasonality. Others, might see their cash flows fluctuate based on their contracts with their clients.

How to Read a Cash Flow Statement

Your cash flow statement breaks down your business into a simple equation:

Operations costs + Asset investments + Financing = Cash on hand

Operations costs: Also called operating cash flow, operations costs show how much you have spent or made on a daily basis. This includes cash that came in for the period and collections of sales previously made on credit, minus assorted regular expenses. It is the most accurate assessment of how much money you have generated from your core business. Total net cash is a number you want to see growing.

Asset investments: This section, also called cash flow from investing activities, shows the cash used to sell or buy long-term capital assets for your business. These assets may be equipment, property, machinery, vehicles, furnishings, or investment securities. Over time, you want to see that the business can pay for these investments with income from its operations.

Financing: Here you’ll find the cash received from or paid to lenders, other creditors, and investors (if you have them). For publicly traded companies, this is where cash flow from the sale of stocks and bonds, payment of dividends, or repayment of debt capital is reported.

What Causes Cash Flow Problems?

Like entrepreneur Jay Goltz wrote in the New York Times, “There are many ways to have cash without profit.” Plenty of businesses have folded because they didn’t understand the difference between making money and managing cash flow.

More often than not, cash flow is a challenge because income is sporadic while expenses are recurring. Poor sales aren’t a cash flow problem—that’s a sales or product problem. A cash flow problem is when sales are good, but cash is stuck in inventory or accounts receivable and you owe people money. The cash is coming, it’s just not there yet.

Addressing a cash flow problem is sometimes as simple as unlocking cash tied up in accounts receivable. There are plenty of ways to get paid faster, but that isn’t always the answer. Some companies take on financing against assets, inventory and outstanding payments. That too isn’t a silver bullet.

As Ritika learned, solving her cash flow issues came down to get all of her accounting in order. No more spreadsheets, no more manually reports. Positive cash flow is part of a comprehensive accounting process that is automated and accessible. Having a good accountant helps too.

Nearly every business that graduates from Excel to an accounting software like QuickBooks wishes they did it sooner. Entrepreneurs are capable enough to be accountants, but they usually don’t have the time. If you want to stay on top of cash flow, get people and systems in place long before the problems arise. Your employees, your vendors and your accountant will thank you.

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