What is cash flow and why is it important?

Staying in the black is about more than just profits—cash flow is just as essential for success

WeWork Taunusanlage 8 in Frankfurt. Photograph by WeWork

Cash flow is the pulse of a business. One of the most important metrics for tracking financial fitness over time, cash flow is a snapshot of how much money is flowing into and out of a company at any given moment. Revenue might tell you how successful your sales team is, but knowing how much cash you have on hand—and exactly when you’ll have it—is vital to keeping the lights on.

In this article we’ll take a closer look at what cash flow is and how it works, as well as some of the benefits a well-managed cash flow can bring to your business. We’ll also dive into cash flow statements and how to create them.

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What is cash flow?

Cash flow refers to the total amount of cash moving into and out of your business over a given period. 

The cash flow statement is one of three main documents that measure a company’s health, along with the balance sheet and the income statement. Cash flow is a particularly useful metric because it looks past turnover—which can give a misleading impression of how well a business is truly doing—and focuses instead on which way your funds are actually flowing. 

If you have more money coming into your business than leaving it, then you have a positive cash flow. You can continue covering costs and paying bills, salaries, and suppliers indefinitely. 

If more money is leaving the company than coming in, then you have a negative cash flow—and a potential problem. You’re running out of money, and unless something changes, you’ll need to find a source of funding to continue operating.

Types of cash flow

Three types of cash flow appear on a cash flow statement. These are operating cash flow, investing cash flow, and financing cash flow.

  • Cash flow from operating activities

Your operating cash flow is the one most people have in mind when thinking about how money moves through a business. It’s simply the total cash received from sales minus your operating expenses. That includes things like rent, utility bills, supplies, and salaries.

  • Cash flow from investing activities

Your investing cash flow is a measurement of any funds the business spends or earns related to investment activities. This includes the purchase or sale of physical assets such as property and equipment, the trading of shares in other companies, and business acquisitions. 

  • Cash flow from financing activities

Your financing cash flow is a measurement of all the cash activities related to how the business is currently being funded. It tracks how money is moving between the company and its various creditors, investors, and owners, and includes debt, equity, and dividends.

Benefits of positive cash flow and why it’s important

Cash flow isn’t always the most important metric of a company’s overall health. For example, when a larger business is investing in its future through acquisitions or purchasing commercial real estate, cash flow statements might be sent into the red even though the company’s future looks solid.

But cash flow is very important for small businesses with few investors and limited access to credit, or for seasonal businesses that need ample cash reserves to survive quieter months of the year. If the cost of goods is outstripping sales or your clients aren’t paying up on time, a business can find itself profitable and in possession of valuable assets, equipment, and inventory but still without enough cold, hard cash to cover expenses like utility bills and employee salaries.

Cash flow vs. operating income

Cash flow and operating income are not the same. Operating income is determined by subtracting a company’s operating expenses from its gross income, which gives a measurement of how much of a company’s revenue will be turned into profit. Tracking this figure helps investors get a clearer picture of a company’s true profitability by removing one-off charges like tax bills and debt interest.

Cash flow vs. revenue

Cash flow and revenue are not the same. Cash flow is the balance of money coming into and leaving the business. Revenue is the total income a business earns through the sale of its products and services before expenditures are deducted.

You might hear revenue referred to as a company’s “top line”—this is because revenue is the first figure listed in an income statement, and represents a business’s gross sales and investment income before deductions. Cash flow doesn’t measure this; it instead tracks the amount of cash being transferred into and out of the company.

Cash flow vs. profit

Cash flow and profit are not the same. Cash flow is the balance of cash coming into and leaving the business over a given period. Profit is what’s left over after a business subtracts its expenses from its revenues. 

Those might sound like similar ideas, but while profit can be positive or negative (otherwise known as a loss), it doesn’t necessarily leave or enter the business in the same way as cash. Profit is either shared among the company’s owners and investors as dividends (at which point it becomes a financing cash flow) or reinvested back into the company.

Managing cash flow: steps 

Different types of businesses will face different challenges when it comes to managing cash flow, but here are a few general tips to help ensure you remain on top of things and stay out of the red.

  • Monitor your cash flow. You can’t manage what you can’t see. As a business owner, you’re responsible for keeping accurate financial accounts, but it’s important to be extra diligent about tracking your cash flow as it fluctuates throughout the year. Careful analysis will help you spot shortfalls before they happen.
  • Get paid on time. Speed up invoicing by submitting invoices as soon as the work is finished or the products are delivered. When cash flow is a tight margin, and you’re working at scale and are sure the trade-off is worth it, you might consider incentivizing early payment with discounts.
  • Keep track of stock. Unsold inventory occupies space that you’re paying for and is cash you can’t access. Careful stock management is key to balancing cash flow, especially for businesses working with perishable goods.

Getting a cash flow statement

You can create your own cash flow statement in your preferred spreadsheet editor, but it’s a better idea to take advantage of one of the many free templates available online. Your accounting software should also offer the option to quickly generate a cash flow statement using the data it’s already collected.

Microsoft Office has a cash flow statement template built into Excel, which features sparklines and conditional formatting to make those figures shine. 

Google Sheets also hosts several cash flow statement templates, each offering varying levels of insight and control. Sheetgo is highly customizable to match your business needs, while Shopify has made its cash flow management tool available as an online spreadsheet that’s easy to dip into and edit as you please.

Steve Hogarty is a writer and journalist based in London. He is the travel editor of City AM newspaper and the deputy editor of City AM Magazine, where his work focuses on technology, travel, and entertainment.

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