Cash flow guide: Definition, types, how to analyze

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?
• What is a cash flow statement?
• Cash flow statement example
• Why being cash flow positive is important to your business
• The 3 types of cash flow
• How to read a cash flow statement
• Cash flow analysis
• 5 tips for cash flow management
• Cash flow you can bank on

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.

It’s one of the key financial statements, along with the income statement and balance sheet. You need both the income statement and balance sheet to put together the cash flow statement.

Cash flow statement = income statement + balance sheet

Cash flow statement example

Let’s look at an example of a cash flow statement. The example includes all three of the key sections as well as the ending cash balance that will show up on the balance sheet.

Why being cash flow positive is important to your business

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. 

Cash flow can be challenging because income is sporadic, but expenses are recurring. Here’s a simple three-step process for working through an analysis of your cash flow. 

1. Create a cash flow statement

Creating a cash flow statement is easy to generate from your accounting software, if you use it. Sign up for your free QuickBooks Online trial to see if its the right accounting software for your business. You can also compile your income statement and balance sheet. Then use those to calculate your operating, investing, and financing cash flows. 

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.

Find where the bulk of your cash is going, which could be loan payments or inventory. This could mean you need to refinance debt. Or better manage inventory. 

Then see how you can get cash faster. Look at long it takes your average customer to pay if you’re billing them.

A cash flow analysis will provide an accurate view of your business’s finances. From there, you can make smarter budgeting decisions.

Free cash flow

Free cash flow is a helpful metric for analyzing cash flows. It’s the operating cash flow a company generates minus capital expenditures. Capital expenditures (CapEx) is the money you invest in your fixed assets over a period, plus the depreciation expense.

Free cash flow = operating cash flow - capital expenditures

Think of free cash flow as the money a business makes from operations after investing in fixed assets. Free cash flow helps assess your ability to repay debt or pay dividends.

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.

QuickBooks helps small businesses manage finances with automated cash flow analysis reports. Such tools can free up time for owners to focus on growth. Explore how QuickBooks’ cash flow tools can help you forecast the money you’ll have coming in and going out of your business.

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:

1. Identify the period you plan to analyze
2. Adjust net income for non-cash items and working capital changes
3. 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

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. 

Another way to encourage early payment is to make it easy for customers to pay invoices using the payment method that works best for them. Use QuickBooks Money to send instantly payable invoices that get paid up to 4x faster than paper invoices.1 Customers can choose the payment method that’s most convenient for them, including credit or debit card, ACH bank transfer, Apple Pay, PayPal, or Venmo.

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.

Cash flow you can bank on

Maintaining a healthy cash flow and understanding what is cash flow is crucial for any business owner. That all starts with knowing what to look for and how to use that information to calculate your cash flow.

But this also means having an accounting system that makes it easy to track inflows and outflows. Learn more about how QuickBooks can help your small business manage cash flow.

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