Understanding Cash Flow: Essential Tips for Managing Your Business Finances
By Your Front eOffice
As a small business owner, cash flow is crucial. But what exactly is cash flow? It’s the money moving in and out of your business bank account. Knowing where your cash comes from and where it goes is essential for making smart decisions.
You can think of cash flow like the gas in your car. You fill up the tank, and it gets used up as you drive. The goal is to keep enough gas in the tank so you don’t run out. This guide will explain what cash flow is, how to analyze it, and how to read cash flow statements to help you manage your business better.
What is Cash Flow?
Cash flow is simply the money that comes into your business (inflows) and the money that goes out (outflows). Net cash flow is what’s left after subtracting the outflows from the inflows.
Cash flow is recorded on a cash flow statement, which shows:
- Operating cash flow
- Financing cash flow
- Investing cash flow
Cash Inflow vs. Cash Outflow
Cash inflows are the money that enters your bank account. Examples include:
- Payments from customers
- Money from selling assets
- Loan proceeds
Cash outflows are the money that leaves your bank account. Examples include:
- Credit card or debt payments
- Payments to suppliers
- Purchases of inventory
Cash Flow vs. Profit
Net cash flow, as shown on the cash flow statement, is different from net profit, which is shown on the income statement.
- Cash flow refers to the money moving in and out of your bank accounts.
- Net profit is your revenue minus expenses.
Some expenses affect profit but not cash flow, like depreciation. On the other hand, a large cash outflow, like paying off debt, reduces your cash balance but doesn’t affect profit. This means net cash flow and net profit won’t always match.
Cash flow statements use cash basis accounting, tracking when cash changes hands. Income statements use accrual accounting, recording revenue and expenses when they occur. For example, if you pay $1,000 upfront for a two-year software subscription, the cash flow statement will show a $1,000 outflow immediately. But the income statement will spread that $1,000 expense over 24 months.
What is a Cash Flow Statement?
A cash flow statement, also called the statement of cash flows, records the cash paid or received by a business over a certain period. It’s one of the main financial statements, along with the income statement and balance sheet. You need both the income statement and balance sheet to create 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
For small businesses, it’s important to aim for positive cash flow. Positive cash flow means you’re bringing in more money than you’re spending, which is essential for:
- Paying bills
- Buying equipment and inventory
- Investing in growth opportunities
- Repaying debt
The 3 Types of Cash Flow
Cash flow statements have three main sections:
- Operating Cash Flow
- This is cash from your core business activities, like selling products or services. It includes customer payments, payroll, and inventory purchases.
- To calculate operating cash flow, you’ll start with net income and adjust for non-cash items like depreciation and changes in working capital.
Operating cash flow = Net income + non-cash items + working capital changes
- Investing Cash Flow
- This involves money spent on or received from long-term assets like equipment or machinery. Buying equipment is an outflow, while selling assets is an inflow.
- Financing Cash Flow
- This includes cash received or paid to lenders, investors, or other creditors. Taking out a loan is an inflow, while repaying debt or paying dividends are outflows.
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