• What is cash flow?
• Why is managing cash flow important?
• How does cash flow work?
• Types of cash flow
• How to read a cash flow statement
• Monitoring cash flow cycles
• Creating cash flow to run a successful business
• FAQ

Cash flow is essential for a business to thrive, and it helps support daily operations.

For small business owners and self-employed individuals, managing cash flow involves monitoring the inflow and outflow of money to ensure financial health. 

In this article, we will explain what cash flow is and how it works. You'll also learn how to use a cash flow statement to avoid financial shortfalls, make informed decisions, and build a strong foundation for your business to thrive.

What is cash flow? 

When running a business, cash flow is the total amount of money entering and exiting the business.

It measures the net balance of: 

• Cash inflows: revenues such as sales of goods and services
• Cash outflows: expenses such as payroll and inventory

Generally, cash flow is measured on a monthly basis, but it can also be monitored quarterly or yearly.

Effective cash flow management is vital for maintaining liquidity and ensuring a company can pay its financial obligations on time and continue to operate.

Positive vs. negative cash flow 

Positive cash flow occurs when a company has more money coming in than going out. This allows it to cover expenses, reinvest in the business, return money to shareholders, and build a cash reserve for future needs.

Having consistent positive cash flow means a business is financially healthy. 

Negative cash flow means more money is leaving the company than coming in, indicating financial trouble and the inability to pay for operational expenses.

Having ongoing negative cash flow may lead to insolvency and potential bankruptcy.

Why is managing cash flow important? 

Calculating cash flow is crucial because it ensures a business can cover operating expenses and capital expenditures, leaving free cash flow for other uses. 

Positive cash flow enables a company to pay bills and make new investments. It can also help reduce financial stress for owners and managers.

Ultimately, adequate cash flow allows a business to operate smoothly and supports long-term stability.

How does cash flow work? 

Let’s say that you own a food truck and want to understand how much money is passing through your business.

In one month, you recorded sales of the following items:

• Hamburgers: $4,000
• Fries: $2,000
• Cans of pop: $1,060
• Total = $7,060

These sales are recorded as revenue and refer to the cash flowing into a company.

You also need to cover the operating costs: 

• Kitchen supplies: $500
• Rent: $2,000
• Employee payroll: $2,000
• Total = $4,500

These expenses are the cash flowing out of your business. 

Therefore, your incoming cash of $7,060 minus the outgoing cash of $4,500 leaves you with $2,560 of positive cash flow.

Types of cash flow

The more cash coming into your business, the more you can allocate to your business operations or reinvesting.

There are three main types of cash flow that dictate how money is used within a business:

1. Operating cash flow, which is net cash produced from a company's regular business operations, reflecting its ability to generate enough cash to pay its bills and sustain growth.

2. Investing cash flow involves cash spent or generated from investment activities such as purchasing assets or securities. Typically, it often shows negative cash flow in companies actively investing in their future.

3. Financing cash flow refers to cash movements between the company and its investors, owners, or creditors — including issuing debt, equity, and paying dividends. It provides insight into a company's financial strategy and capital management.

How to read a cash flow statement

A cash flow statement is a financial document that provides a detailed analysis of how cash moves in and out of a business during a specific period.

There are three specific categories: 

• Operating: selling of goods and services
• Investing: selling assets such as real estate or machinery
• Financing: borrowing money through loans or selling company shares

This statement helps measure a company's cash position, which shows how well it manages and generates cash to pay for expenses and liabilities. 

Analysts, managers, and investors use this financial document to assess a company's ability to meet its financial obligations and sustain operations. 

Small businesses can provide investors with their cash flow statements to show how much money they can generate.

Your business can create this document using this cash flow statement template.

How to analyze a cash flow statement

Cash flow statements can provide an overview of the past month, quarter, or year to illustrate how much cash was earned and spent.

One of the main benefits is that it can help you analyze trends over several periods and see the big picture of the fluctuations in the cash balance.

When you compare the past performance (such as month to month or year over year), you can:

• Determine if you have a cash flow surplus or deficit.
• Identify times of the year when you have excess cash or a shortfall.
• Monitor your financial growth to make any necessary adjustments.

Monitoring cash flow cycles 

Monitoring cash flow cycles is essential for maintaining your business's financial health. Every business experiences natural fluctuations in cash flow.

By regularly reviewing monthly cash flow statements, you can identify these cyclical patterns. Understanding when the ebbs and flows occur will allow you to make informed decisions about when to invest in major expenditures or seek more capital from potential investors. 

The length of your cash flow cycle determines how long your money is tied up in the business, which will impact your liquidity.

Shorter cycles and higher profit margins generate more free cash, providing greater financial flexibility and enabling your business to thrive.

Longer cycles mean your money is held up, which makes it challenging to use that money for other business objectives.

Creating cash flow to run a successful business 

Effective cash flow management is vital for business owners. By tracking the inflows and outflows of cash through your business, you can maintain a healthy financial position.

Understanding how to read and analyze a cash flow statement helps you plan ahead, so your business can stay profitable and prepared for future growth.

Successful cash flow management gives you peace of mind so you can maintain the optimal amount of cash. Try QuickBooks today to help you manage your accounting and cash flow needs.