What is cash flow and how does it work?

Small business owners know how important cash flow is to keeping a thriving business. According to the 2025 Intuit QuickBooks Small Business Index Report, 2024 was one of the toughest for small business owners—the average revenue fell by nearly $12,000 per business. 

With such losses, business owners must make intentional and strategic cash flow decisions to help overcome future challenges. In this article, we’ll define cash flow, tell you how it works, and give you tips on managing it effectively.

What is cash flow in business?

Cash flow is money that moves in and out of your business bank account. Picture your cash flow as your car’s gas tank. You fill the tank with gas to keep the vehicle (your business) moving forward.

The goal is to have enough gas in your tank so you never run on empty.

Having enough gas in the tank signifies positive cash flow or more money coming in than out. Meanwhile, negative cash flow, the opposite situation, is when your car is always running out of gas. If the car (business) stops, no progress is made, potentially halting operations or cash-driven activities.

Understanding this movement empowers you to make informed decisions, such as funding daily operations, buying new equipment, or investing in the financial markets.

What is net cash flow?

Your net cash flow is the difference between cash outflows and inflows. Investors and stakeholders look towards this information, available on your statement of cash flows, to learn more about how you handle your financial obligations. 

What are liquid assets?

Cash and other liquid assets inform how easily you can manage your immediate financial obligations. A liquid asset is a current asset that you can easily and quickly convert into money. Examples include marketable securities, short-term treasury investments, and goods held for sale.

Cash inflows vs. outflows

Cash inflows include any money going into your account, such as customers paying invoices, while outflows include any cash going out, such as paying bills. Here are a few more examples:

Cash flow isn’t concerned with money owed or to be received; it’s only concerned once money changes hands. For example, the money you receive when taking out a business loan counts as an inflow. When you start paying the loan, this is an outflow.

Cash flows vs. profits

Your net cash flow from the cash flow statement represents something different from your net profit on the income statement. Profit margins, or revenue minus expenses, might not always indicate that you’ve gained or lost money.

For example, some expenses affect your profit but are not cash flows, such as depreciation expenses, including the lost value of assets (like aging buildings). In addition, you could have high profits and a low cash flow, which could result from significant capital expenditures draining your available cash.

The same could be true in reverse, as cash flows don’t always affect your profit. For example, paying off your entire debt early could be a considerable cash outflow that lowers your balance. But your profit goes unaffected, as your balance sheet already tracks this expense. This means that net cash flow will not always match net profit. 

Generally, existing and potential shareholders use cash flow over profits to understand the actual money coming into and going out of their business. 

Accrual vs. cash basis accounting

Cash flow differences are reflected in the accounting type as well. A cash flow statement uses cash basis accounting, while an income statement can also use 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, paying for a two-year software subscription of $1,000 upfront appears differently on the two statements. Your cash flow statement shows a $1,000 cash outflow on the day you paid. However, the income statement breaks down the $1,000 expense over 24 months.

The 3 types of cash flow

There are three key sections on the cash flow statement—the operating, investing, and financing cash flows. The type of cash flow varies based on where you get the money or what you spend it on.

Operating cash flow

Operating cash flow (CFO) includes cash from core business activities that involve the sale or production of your goods or services. Examples include customer payments for products, payroll, and inventory purchases.

Calculating your operating cash flow starts by getting net income. You’ll also need to remove noncash expenses like depreciation and changes in working capital. Here’s the formula:

Operating Cash Flow = Net Income + Noncash Items + Working Capital Changes

Investing cash flow

Investing cash flow (CFI) is the money a business spends or earns on investments, particularly long-term assets. This includes purchasing or selling fixed assets like equipment, property, and marketable securities.

For example, if a construction company purchases a new bulldozer, the payment for this vehicle counts as an investing cash outflow. The cash the eventual sale creates when the company is done with it is a cash inflow. 

Other examples include mergers, where the properties, people, and buildings become part of one another, although this is less common in small businesses. Here’s the formula for investing cash flow:

Investing Cash Flow = Cash Inflows from Investment Activities - Cash Outflows for Investment Activities

Financing cash flow

Financing cash flow (CFF) is the money you pay or receive from lenders, investors, or other creditors, excluding what’s already part of CFI. Any cash flows related to debt or equity fall into this category. 

For example, if you took out a business loan, the money received is a cash inflow. Paying back the interest and principal of that loan is a cash outflow. However, if you use this loan to purchase new equipment, that trade falls under CFI.

To calculate your financing cash flow, review transactions related to borrowing, debt repayment, issuing stock, and paying dividends. Here’s the formula for financing cash flows:

Financing Cash Flow = Cash Inflows from Financing Activities - Cash Outflows from Financing Activities

Financing cash flow tells investors how effective a company is at raising or borrowing money. You can then reinvest these funds into further financing activities or back into operations to fund your business’s growth. 

What is a cash flow statement? 

The cash flow statement is a record of cash paid or received by a business over a given period. You can create a cash flow statement based on its type (operations, financing, or investing) or create a more general statement for a high-level overview. 

A cash flow statement is a key financial statement, along with the profit and loss statement and the balance sheet. You can use information from both documents to create a statement of cash flows. 

Below, you’ll see an example of a cash flow statement. 

How to analyze your cash flow

Analyzing your cash flow starts by creating a cash flow statement. This statement already excludes your profits, which business owners sometimes misinterpret as cash flow. 

Cash flow can be challenging because income is sporadic, but expenses are recurring. Sign up for a free QuickBooks Online trial to find out how you can use accounting software to easily generate a statement of cash flows.

You can also do it yourself using this three-step process to work through an analysis of your cash flow.

1. Identify trends

Using current and past accounting data, see if you can generate a statement of cash flows for each month, quarter, or year. Analyzing multiple statements will allow you to identify regular cash-draining trends that limit your business.

Find where the bulk of your cash goes over time, whether loan payments or inventory. This could mean you need to refinance debt or better manage inventory. Statements from multiple periods will help you differentiate whether you’re looking at one-time instances or consistent issues.

2. Identify free cash flows

Free cash flow (FCF) is the operating cash flow a company generates minus capital expenditures found under ICF, like buying new equipment. FCF is used by investors to determine what money is available to creditors after everything else.

Free Cash Flow = Operating Cash Flow - Capital Expenditures

A high FCF tells investors that a company can pay its bills each month, which might indicate the company is ready to grow. A low FCF means less money is available after paying business expenses, which might indicate the business could benefit from restructuring to save on operational expenses. 

3. Set cash flow goals 

Identifying major issues can help you make 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 cash flow analysis reports. Such tools can free up time for owners to focus on growth. Explore how QuickBooks’ cash flow management 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.

1. Practice calculating it yourself

A great way to understand cash flows in business is to practice calculating them. Here are the steps to get you started using the direct method:

1. Collect information: Identify the period you plan to analyze and collect information from income statements, balance sheets, and bank statements.
2. Collect your CFO information: Collect information on cash sales to customers and collections from accounts receivable and subtract it from cash payments to suppliers, employers, utilities, or other operating expenses.
3. Collect your CFI information: Collect information from cash from the sale of long-term assets and subtract the cash spent on purchasing other long-term assets.
4. Collect your CFF information: Collect information from cash received for financing activities, like issuing stock or borrowing money, and subtract it from debt or dividend payments. 
5. Summarize your cash flows: Add up the cash flows from the three activities to get your total net cash flow number.

You can also choose the indirect method to retrieve this information, which starts with net income, adding back noncash expenses while adjusting for changes based on your working capital. You can adjust these steps to focus on operating, investing, and financing cash flows.

2. Collect cash sooner

Getting money sooner boosts short-term cash flow. You can improve the speed of cash flow by providing incentives for faster payments and encouraging buyers to pay for a portion of the invoice upfront.

Buyers will be encouraged to pay sooner by offering discounts to those who pay before the due date. For example, you can offer a 2% discount if you get the payment within 10 days of invoicing. Remind customers via text or email about any early payment promotions.

Another way to encourage early payments is to impose penalties, such as late fees, for those who make payments three or more days late. Customers may frown upon late fees, but fees provide an incentive to keep your payments coming on time. Include these as part of the payment terms when making a sale.

You should also make invoice payments simple and flexible, covering the customer’s preferred method. Use QuickBooks Money to send instantly payable invoices that get paid faster than paper invoices. 

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. You can even request same-day deposits at no additional cost.

3. Improve inventory management

Improving inventory management can get products out of your door faster. Receiving products quickly will encourage customers to pay faster. It will also help you receive new inventory to sell at a faster rate, helping you maintain a consistent cash flow.

Here are just a few inventory management strategies:

• Use effective technology: Rely on tools, like QuickBooks Advanced Inventory, to track results and automate processes to help reduce human involvement. Fewer human errors will result in a smoother inventory flow. 
• Establish inventory controls: Understand what inventory control system works for your business. For example, if you sell high-value items, you might benefit from an always better control (ABC) system.
• Forecast demands: Predict future needs to help avoid stockouts or overstocking, which can delay inventory shipments. Demand forecasting tools are part of some inventory management tools.

When managing inventory, you should also consider the effectiveness of current suppliers necessary to get your inventory out. For example, if one of your suppliers is consistently behind schedule, discuss your problems with them or consider other suppliers. 

4. Build cash reserves

Cash reserves help cover you when your cash flow slows down or stops. As a business owner, you can't expect every speed bump. However, it does help to have a rainy-day fund to pay for any unforeseen expenses.

Companies should keep enough cash to cover business expenses for three to six months. To find out how much you need, review your cash flow statements from the past few months or years. This will reveal what you’ll need to build a comfortable reserve.

5. Project your cash flow

Cash flow projections give you a look at future cash flows, which can be anywhere from a few months to years later. Knowing your short- and long-term cash needs will help you better prepare for the upcoming months.

When projecting your cash flow, look at past cash flow information from sales and accounts receivable. Then, subtract both your fixed and variable costs from this amount. Consider any unusual events that might be throwing off numbers for that month, such as unusual shipment delays, as including those could throw off your budget.

Projections are how you set up a realistic budget for your business. This budget information can help you make more confident financial decisions. 

Cash flow you can bank on

Maintaining a healthy cash flow starts with understanding where your cash is going, knowing what to look for, and how to use it to benefit your business. While a statement of cash flows helps, a solid accounting system can help improve this process.

QuickBooks Money can help your cash flow work for you through instantly payable invoices sent to customers, management of multiple payment types, same-day deposits, and insights into your cash flow. With the right tools, you can simplify cash flow management and your overall accounting processes.

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