When it comes to the operations of a business, cash is the lifeblood that circulates through a company. Cash flow, like blood flow, is required to stay alive and therefore needs to be closely monitored to ensure the optimum financial health of a company.
As a small business owner or self-employed individual, you will be responsible for cash management and the inflow and outflow of money that enters and exits your business. But what is cash flow in business, how does a cash flow statement work, and how can it help to keep your doors open?
These topics will help you understand more about cash flow and it’s role in small business management:
- Why is Cash Flow Important?
- How to Calculate Cash Flow
- How to Create a Cash Flow Projection
- How Free Cash Flow Affects Your Business
- How to Track Cash Flow
- How to Manage Cash Flow
- 10 Tips for Using Cash Flow Management to Grow Your Business
- How to Improve Cash Flow for Small Businesses
- What is Negative Cash Flow and How to Manage It
Cash Flow Definition
Cash flow is the movement, or flow, of money, whether physical or virtual, into and out of a business. Typically, a company’s cash flow is measured every month or more. Generating cash flow is one of the most important aspects of a business, as it is what allows them to continue to operate.
Cash flow example
The inflow and outflow of cash spans all areas of the business. Cash is coming into the business’s accounts when they sell their goods and services to customers, generating revenue. Money flows out of the business when it needs to pay for expenses, such as rent, payroll, and inventory purchase orders.
For example, Rebecca runs an art supply store and wants to get a handle on the money passing through her business. In one month she recorded the sale of 170 paintbrushes, 89 canvases, and 226 tubes of paint, making a total of $7060. These sales are recorded as revenue and refer to the cash flowing into a company.
But Rebecca also has to pay operating costs for her business, purchasing more art supplies for her inventory, paying rent for her storefront, and paying her other employees. She must pay for these expenses, creating an outflow of cash from the company. Her expenses covering these operating activities amounted to $4500. Therefore, Rebecca has a positive cash flow this month, as she made $7060, spent $4500, leaving her with $2560 of net income, or cash on hand.
What is Good Cash Flow?
When it comes to measuring cash flow, businesses should seek to have a positive cash flow over a negative cash flow.
Positive cash-flow means a company is increasing its liquid assets, allowing them to cover expenses, reinvest in the business, pay off shareholders while also possessing a cash reserve to offset future financial issues that might arise.
In contrast, negative cash flow is the lack of such liquid assets, meaning a company is in financial trouble and cannot pay for the operating activities and expenses required to run properly. Just like the names suggest, it is a positive thing when you have money circulating through the company, a negative circumstance when it does not. Lack of cash flow is one of the main reasons for small businesses to fail.
To learn more about cash flow, read the e-book, Beginner’s Guide to Cash Flow online. Resources such as this can help you gain a better grasp of the importance of cash flow and how cash management can drive a business forward.
How is Cash Flow Used?
The more significant the cash inflow you have, the more money you can allocate to your business operations, reinvesting back into the company for various purposes. Three main types of the cash flow will dictate how the money is used within a business. These types of cash flow include:
- Operating Cash Flow: Refers to all money generated by the company’s central business objectives and regular operating activities.
- Investing Cash Flow: Includes all acquisitions of capital assets and investments in other business activities.
- Financing Cash Flow: Refers to the money gained through issuing debts, equity, and other company-related expenses and payments.
Free Cash Flow
Free cash flow, or FCF, refers to the cash a business generates after it has accounted for the outflow of money towards operations and maintaining capital assets. Simply put, FCF is the money left over after these expenses have been paid for and are used to repay creditors and pay interest to investors.
Businesses use free cash flow as a measurement of the profitability of the company, as it illustrates how efficient the company is at generating revenue. Free cash flow affects your business in many ways. It should, therefore, be measured and monitored over multiple periods and against the industry standards to ensure the company is operating successfully.
The Cash Flow Statement
A cash flow statement is a financial document that illustrates how and where the money is entering and exiting the business at a specific point in time. Generally, cash flow statements are generated for a month and will depict the company’s operating cash flow, investing cash flow, and financing cash flows to determine the total cash balance.
This statement of cash flow is used to measure a company’s cash position, determining how well they manage and generate cash to pay off expenses and other liabilities. This document illustrates the amount of cash the business has running through the company at any given time. To populate the cash flow statement with your business’s financial information, you will need to reference the last year’s income statement and balance sheets.
Small businesses should use this cash flow statement to show investors how much money they can generate. Your business can create this document using this cash flow statement template.
Cash Flow Cycles
Every business has a natural cash flow cycle. Funds ebb and flow at certain times. Reviewing monthly cash flow statements helps you recognize cyclical patterns. Understanding and analyzing these monetary cycles can lead to wiser decisions. For instance, you can better determine when to make a major purchase or when it’s time to seek additional capital from investors.
Your cash flow cycle length is essentially the amount of time from the start of production, when you begin the service or purchase materials, to when you sell the service or product and collect your cash. The longer your cash flow cycle, the longer you have money tied up in the business that you can’t use for other purposes.
Ideally, each cash flow cycle will generate some profit and therefore will generate free cash. The higher your profit margin, the more cash you will generate. There are a few things you can do to manage the length of your cash flow cycle and generate the highest amount of positive cash in each cycle.
Cash Flow Monitoring with QuickBooks
Cash flows in and out of a business every single day. That’s a lot of information to keep track of. Need help recording, monitoring, and improving your business’s cash flow? Consider using accounting software to track operating costs and revenue, calculate net income, create an income statement, provide business insight with profit and loss statements and cash flow projections.
Successful cash management can help improve your business and provide you with peace of mind that you have the optimal amount of cash to keep running accordingly. QuickBooks Online has helped millions of users get a handle on their books, why not join them?