What Is Cash Flow? Almost Everything You Need to Know

Become a master of business cash flow with this comprehensive guide—and watch your business thrive as a result.

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Have you ever found yourself at month-end scrambling to find cash to cover your expenses? Are your expenses constantly higher than your cash on hand? Do you struggle to define “cash flow”? If you answered yes to any of these questions, chances are, business cash flow isn’t one of your areas of expertise.

You’re not alone. Many small business owners struggle with cash flow issues, for various reasons, including feast-or-famine cycles, slow work periods, late-paying clients, or unplanned expenses that throw their budgets out of whack.

Understanding business cash flow is the first step to ensuring that you have enough cash on hand to cover your expenses at any given time. But what, exactly, is cash flow? Why is it so important to your business? And what steps can you take to improve cash flow?

table of contentsTable of Contents

    What Is Cash Flow?

    Before we dive too deep into all things cash flow, let’s take a moment to define what, exactly, cash flow is. Simply put, cash flow is the total amount of money flowing in and out of your business.

    When you have more money flowing into your business than out of your business, you have a positive cash flow. When you have more money flowing out of your business than you do coming in, you have a negative cash flow. (Negative cash flow is also sometimes called being “in the red.”)

    Cash Flow vs. Profit and Revenue

    It’s important to note that cash flow isn’t the same thing as profit or revenue. Cash flow measures all money coming into and going out of your business—not just money you make from normal business operations (revenue). Profit is revenue minus expenses, which also only accounts for cash flow from operations.

    This means a business could have a positive cash flow and still be considered unprofitable—say, the cash inflows are from sources other than operations, such as borrowing.

    Example:

    You decide to take out a business loan for $25,000. Because it’s money coming into your business, that $25,000 would improve your cash flow—but because it’s not actually revenue from selling your product or service, it wouldn’t have any impact on your profitability.

    mastering cash flow

    Why Does Cash Flow Matter?

    Now that you understand what cash flow is, it’s important to examine why positive cash flow is so critical to your business.

    It keeps operations moving forward. Your business doesn’t stop running while you wait to get paid. Without sufficient cash on hand to cover your expenses, your business operations could come to a screeching halt. Understanding cash flow allows you to run your business in a way that balances cash in vs. cash out—which allows you to keep operations progressing.

    It informs your business strategy. Understanding cash flow can help you make better strategic decisions for your business.
    For example, let’s say you need to buy new equipment for your office. Calculating your business’s cash flow can help you make the best decision around when to buy the equipment and will help prevent a cash deficit in your business.

    It helps you plan for the future. Digging into your cash flow data can also help you better plan for your business’ future. Consider this scenario: You own an artisanal ice cream shop and your company generates much more cash in the summer than the winter. Understanding your cash flow can help you set aside enough cash to cover your operating expenses in the slower seasons.

    3 Types of Cash Flow

    There are 3 areas of your business that impact cash flow: Operations, financing, and investments.

    1. Cash Flow from Operating Activities

    Your operating cash flow is the money moving into and out of your business related to your normal business operations.

    Inflow example: money received from your clients

    Outflow example: money paid to cover rent, utilities, travel, cell phone, and other expenses

    2. Cash Flow from Financing Activities

    Any money flowing between your business and its owners and creditors are known as financing activities .

    Inflow example: cash received from a bank loan

    Outflow example: monthly loan repayments

    3. Cash Flow from Investing Activities

    Buying or selling an investment results in negative or positive cash flow for your business. When calculating cash flow, purchasing or divesting physical assets like buildings, land and vehicles, are considered investing activities.

    Inflow example: money received from selling investment funds or equipment

    Outflow example: money paid to purchase investment funds or equipment



    Cash Flow Statements: How to Calculate Cash Flow

    You know what cash flow is. You know why it’s important. But how, exactly, do you determine your cash flow?

    Calculating cash flow usually involves preparing a cash flow statement. Along with the income statement and the balance sheet, the cash flow statement is one of the most important financial statements for understanding your business.

    While your balance sheet can show you much cash you have, cash flow statements show the details of how and where cash is coming into and out of your business (the cash inflows and cash outflows), during a specific time period.

    You can create a cash flow statement for any timeframe, but most business owners generate the report monthly.

    Cash flow statements are broken up into 3 sections that match the 3 types of cash flow covered earlier:

    1. Operating Activities
    2. Investing Activities
    3. Financing Activities

    There are 2 ways to prepare a cash flow statement: The indirect and direct method.

    1. The Indirect Method

    It might sound counterintuitive, but the indirect method is actually the simpler way to prepare a cash flow statement—and, as such, is the one most commonly used.

    When using the indirect method, you adjust your net income based on cash inflows and outflows to see how much cash you have available.

    Example:

    You own a boutique marketing agency, and your net income for the month of March was $10,000.

    From an operations standpoint, you had a client pay an invoice from last month for $1,000 and you’ve billed clients for an additional $2,000 of marketing services for this month.

    From an investing perspective, you purchased new office furniture for your team, which cost $2000—but you also sold some of the old furniture, which brought in $1,000.

    And from a financing perspective, you had $900 cash come in from your agency’s business line of credit—but you also had to pay $200 towards the balance.

    In that situation, your cash flow statement (using the indirect method) would look like this:

    XYZ MARKETING AGENCY CASH FLOW STATEMENT – MARCH

    Cash Flow from Operations
    Net income                                          $10,000
    Increase in Accounts Payable            $1,000
    Increase in Accounts Receivable      ($2,000)
    __________________________________
    Net cash from operations                   $9,000

     

    Cash flow from investing
    Purchasing equipment                       ($2,000)
    Selling equipment                               $1,000
    __________________________________
    Net cash from investing                     ($1,000)

     

    Cash flow from financing
    Money from business line of credit   $900
    Payments on business line of credit ($200)
    __________________________________
    Net cash from financing                     $700

    Ending cash flow balance                  $8,700

    On the cash flow statement, your ending cash flow balance is calculated by taking your net income and adding/subtracting your net cash from operations, investing, and financing.

    2. The Direct Method

    Often the go-to for larger businesses, the direct method takes a more detailed approach, listing all of your cash income and payments or expenses separately, line by line.

    While this can give you deeper insights into exactly where your cash is coming from and where it’s going, it’s also a lot more time-consuming and labor-intensive to prepare. So unless you have a specific reason for going with the direct method, as a small business owner, the indirect method is likely your best bet.

    Managing Cash Flow

    chase dreams not payments

    Understanding cash flow is important. But in order to ensure that you have the cash you need to sustain your business, you need to do more than understand cash flow as a concept; you need to track your cash flow, dig into your numbers (also known as cash flow analysis), and figure out how and where you can make changes to push your business away from negative cash flows and towards positive cash flows.

    This is called cash flow management, and it’s critical for keeping your business out of the red. Effective cash flow management has 2 key elements: Being on top of your invoices and your expenses.

    Track Your Income

    Part of cash flow analysis is knowing how much cash is coming into your business and when—and that means tracking your invoices.

    When you send an invoice, it’s important to track when it was sent, when payment is due, when it’s actually paid, and your monthly invoice total. That way, you can get a fairly accurate estimate of how much cash will be flowing into your business each month.

    Example:

    You are reviewing your cash flow for the past 6 months—and realize that, without fail, you have one client that pays their $1,500 invoice a month late. So, even though you’re expecting that $1,500 to come in at a certain time, it’s actually coming in 30 days later—which impacts your cash flow.

    Armed with that information, you can adjust your cash flow forecasting and plan for the deficit and ensure you have enough cash on hand to cover all of your expenses in the coming months. (Also, you may consider getting rid of that client.)

    While you can track your invoices manually, using accounting software will automate the process, making it easier to track payments and manage cash flow.

    Track Your Expenses

    When you track your invoices, you’re aware of the cash flowing into your business—but it’s just as important to see the cash flowing out of your business, which means getting serious about tracking your expenses.

    The more organized you are with tracking your expenses, the easier it will be to dig into your cash flows and use those insights to drive your strategy—so make sure to organize your expenses by category.

    Example:

    Your total expenses are $15,000 per month. If you haven’t broken that $15,000 down into categories, it’s hard to know if and where there are any opportunities to lower your expenses—and improve cash flow in the process. But if you break it down into narrow categories, you can gain more insights into opportunities for cost savings—for example, the $150 you’re spending in overdraft fees at the bank each month.

    Again, you can track expenses manually, but the process will be easier, faster, and more streamlined with the right accounting software. (FreshBooks automatically categorizes expenses for you.)

    4 Ways to Improve Your Cash Flow

    The end goal of managing your cash flow is, of course, to improve it. But how, exactly, do you do that?

    Here are 4 strategies to boost cash flow in your business—and ensure you have the cash on hand you need to move your business forward.



    1. Increase Your Revenue

    If you want to improve the cash flow in your business, one of the best things you can do? Look for ways to make more money. In other words, increase your revenue.
    This might mean selling more of your products or services, raising your prices, or increasing the frequency with which your customers purchase from you.
    And as long as your strategies don’t also increase your operating expenses, you’ll see a boost in your net cash flow.

    2. Lower Your Expenses

    Bringing more money into your business is a solid strategy to improve cash flow. But taking steps to mitigate cash outflow is an equally worthy strategy.
    Look for ways to lower your monthly expenses. While some expenses (like rent or utilities) are likely fixed, you may have wiggle room in other areas—like travel and entertainment, bank fees, or contractors.
    If you can find ways to cut out expenses, it will help to boost your net cash flow—as long as you don’t spend that money elsewhere.

    3. Get Invoices Paid Faster

    Have you ever had a client pay an invoice late? If so, you’re not alone. According to Fundbox, 64% of small business owners face late payment problems. And while the occasional late payment may not be a major concern, if clients or customers chronically pay late, it can wreak havoc on your cash flow.
    Luckily, there are steps you can take to increase the likelihood your invoices get paid on time, including:

    • Set clear payment terms. Our own invoice payment terms analysis shows that invoices with clear payment deadlines get paid faster. Make sure your clients know exactly when payment is due, and avoid more ambiguous terms like “net 30” or “upon receipt.” The clearer you are in your payment terms, the more likely it is your clients will pay promptly.
    • Send reminders. People are busy—and with so much going on, it can be easy to forget an invoice’s due date. Sending reminders before an invoice is due (for example, one week or one day before payment is due) can get your invoice back on your client’s radar—and increase the likelihood they’ll pay on time.
    • Charge late fees. Adding late fees to your pricing structure is an effective way to incentivize clients to pay their invoices on time. Just be sure to outline the late payment penalty clearly in your invoice payment terms.

    4. Be Strategic With Your Invoicing

    Sometimes, maintaining positive cash flow comes down to timing. So, if you want to improve cash flow in your business, you want to be strategic about managing when money is coming in versus when money is going out. Essentially, the better you align your payables and receivables, the better your cash flow.

    Example:

    Your marketing agency sends out client invoices on the 30th of every month. Clients have 30 days to pay their invoices. That means that you’ll generally get an influx of cash at the end of the month—so, if possible, you would want to align any major expenses (like debt repayment or big business purchases) to fall around the end of the month.

    Don’t Let Cash Flow Kill Your Business

    Cash flow is the lifeblood of your small business. Unfortunately, some small businesses don’t fully understand it until it’s too late, and they no longer have the cash to cover the bills.

    Understanding the basics of cash flow—how it impacts your business, how to calculate it using a cash flow statement, and how to improve it—can make or break your business. Armed with this information, you can effectively plan for and anticipate the cash you need to keep your business moving forward.

    This post was updated in March 2022.

    Deanna deBara

    Written by Deanna deBara, Freelance Contributor

    Posted on January 9, 2020