What is cash flow?

Cash flow is the money that moves in and out of your business each month. Cash flow represents how money moves inside and outside the business from month to month. Customer purchases and payments from customers are the money coming in, while business expenses are the money going out. Managing cash flow is especially important for new businesses and seasonal companies. You can run a cash flow report to monitor the cash flow in and out of your business.

How does cash flow work?

Cash flow is the money that moves (flows) in and out of your business over a specific period (such as a month). Incoming cash: This is the money from customers who buy your products or services. If customers do not pay at the time of purchase, some of your cash flow comes from collecting accounts receivable. Outgoing cash: This is the money that leaves your business in the form of expense payments, such as money to vendors, rent for office space, monthly loan installments, taxes, and other accounts payable.

The best way to track cash flow in your business is to run a cash flow report. This report shows the money you received and the money you paid out to show the cash position of your business at the end of each month. Sometimes, you may need to track cash flow on a weekly or even daily basis.

A quick and easy way to conduct a cash flow analysis is to compare the total unpaid purchases with the total sales receivables at the end of each month. If the total unpaid purchases exceed the total sales receivables, you will need to spend more cash than you receive in the following month, indicating a potential cash flow problem.

Note: Your accounting software should include a cash flow statement as one of the standard reports, or your accountant can run it for you.

Example of cash flow

Cash flow is what happens to cash when a customer pays a bill, when your business buys supplies, or when you pay an employee or independent contractor. Cash flows into your business when you receive a payment, and then it flows back out when you pay expenses.

Cash vs. Real Cash

For some businesses, like restaurants and certain retailers, cash is real cash: coins and paper bills. The company takes cash from customers and pays its bills in cash as well. Cash businesses face a particular challenge in tracking cash flow, especially if income is only tracked when there are bills or other paperwork involved.

Think of cash flow as a snapshot of your business’s checking account over time. If more money is coming in than going out, you are in a state of “positive cash flow” and have enough to pay your bills. If more cash is going out than is coming in, you risk being in overdraft and will need to find funds to cover the overdrafts.

Note: Cash businesses are at a higher risk of being audited by the Internal Revenue Service (IRS) because it is easy to hide cash income and not report it.

The Importance of Cash Flow

Cash shortages are one of the biggest reasons small businesses fail. It is also referred to as “running out of money,” and it can close your business faster than anything else.

When Starting a Business

Dealing with cash flow issues is the hardest when starting a new business. You have many expenses, and the money goes out quickly. You may have little to no sales or customers paying you. You will need some other sources of cash, like a temporary line of credit, to get started and create positive cash flow.

The months

The first six months of business are a critical period for cash flow. If you do not have enough cash to support you during this time, your chances of success are not good. Suppliers often do not extend credit to new businesses, and your customers may want to pay on credit, giving you “cash pressure” to deal with.

Note: When estimating your cash flow needs to start a business, include personal living expenses that you will need to take from the business. The lower your personal needs are, the more you can dedicate to your business during the critical startup period.

Seasonal Businesses

Cash flow is also very important for seasonal businesses – those that experience significant fluctuations in business at different times of the year, such as seasonal and summer businesses. Managing cash flow in this type of business is challenging but can be done with care.

Cash vs. Profit

Your business can be profitable, yet have no cash. How can that happen? The short answer is that profit is an accounting concept, while cash, as mentioned above, is the amount available in the company’s business checking account. Profit does not pay bills. You can have assets, such as accounts receivable (money owed to you by customers), but if you cannot collect these receivables, you will not have cash.

Cash Flow Management Requirements

There are steps you can take to better manage your cash flow and avoid a cash flow crisis.

Control Inventory

If you have excess inventory, it ties up cash. Track inventory so you can better estimate your needs. You may find it necessary to reduce prices in the short term to move a lot of inventory and generate cash and return to a better level.

Collect Accounts Receivable

Set up a collection schedule using the accounts receivable aging report as a guide. Follow up on unpaid invoices so you don’t miss those payments. Staying on top of accounts receivable will prevent a cash crisis.

End Unprofitable Relationships

Decide when it’s time to end the relationship with someone who never pays. You can then use that time to focus on customers who contribute to profitability, not detract from it.

Note: If you have time for only one business analysis each month, make it a cash flow report to track your cash position.

How to Get Help with Cash Flow

Many businesses get help with temporary cash flow shortages by setting up a working capital line of credit. A working capital line of credit works differently than a loan.

When you obtain a line of credit, you have a certain amount of credit available in an account that you can draw on when you are short on cash and pay it back when you have extra cash. You only owe interest on the amount drawn. For example, if you have a $25,000 line of credit and you draw $10,000, you will only pay interest on $10,000. If you were to take out a loan instead, you would have to repay the full amount (plus interest) even if you didn’t need it all.

Frequently Asked Questions (FAQs)

What is a cash flow statement?
A cash flow statement is a financial report that shows cash coming in and cash going out of the business. It has three main parts: cash from operations (like sales), cash from investing, and cash from financing (like loans or lines of credit).

What is an example of cash flow?
Let’s assume

You have a company that produces coffee mugs. Customer purchases of the mugs will provide the incoming cash for the company, while salaries will represent the outgoing cash. Cash may also flow in as a result of any investments the company holds, or it may flow out in the form of loan payments, taxes, or infrastructure costs. The cash flow statement will document the movement of these different types of cash.

Source: https://www.thebalancemoney.com/cash-flow-how-it-works-to-keep-your-business-afloat-398180