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What is cash flow? A guide to keeping money moving in your business

Dec 14, 2018 | 4 minutes read | Accounting & taxes

As an entrepreneur, you hustle daily to keep money coming into your business. Understanding how this money moves in and out of your business gives you the power to make your business more sustainable, and to grow strategically.

Small businesses literally live and die by the way their money moves. Once your cash flow dries up, it’s tough to dig yourself out of the hole and it inevitably impacts your business. According to one recent survey, three-fourths of SMBs said they needed more cash. And almost 20% of SMBs fail in their first year and another 50% have shuttered by their fifth year—and this is often due to a stymied cash flow.

Here are the ins and outs of cash flow as well as a glossary of terms to help you grasp the concept and move forward with a plan to keep money moving through your business.

What is cash flow?

As a business, you’ll inevitably have income as well as overhead. You’ll pay for expenses like an office rental, software licenses, and vendor invoices. And you’ll receive revenue, also known as your “cash.”

Cash flow represents the movement of money in and out of your business. Think of it this way: Your cash flow represents all the transactions in your business bank account. When you have more than enough money in your account to cover your bills, you have a positive cash flow. But when the cash flowing out of your business (i.e. expenses) exceeds the cash coming into your business (i.e. revenues and income), that’s when you have a cash flow issue.

Cash flow versus profit

Because cash flow only represents the balance in your bank account, it’s possible for your business to turn a profit and still have zero cash. For example: you might earn a 30% profit on every product you sell, but if you have more expenses than income, you still have negative cash flow.

That’s why it’s important to track your cash flow carefully.

How to track cash flow in your business

The best way to stay on top of your business’ cash flow is to track and analyze it on a regular basis. There are a few ways you can monitor your operating cash flow:

  • Accounting software: Using a tool like Wave can make managing cash flow easy. You can simply run a report for a specific date range (i.e. weekly, monthly, or yearly) to generate a cash flow statement. This report provides you with an at-a-glance view of your sales, purchases, inventory, payroll, and other income or expenses.
  • Set up an accounts receivable/expenses calendar: Create a calendar that marks all the payment deadlines for your customers (i.e. give them a set number of days to pay your invoices). And don’t forget to mark the days specific expenses are due. That way, you have a calendar view of income and expenses and you know when to expect both.
  • Old-fashioned spreadsheets: Many entrepreneurs track cash flow in a spreadsheet. However, all that data entry is a bore and eats into your precious time. So, while manually entering all your expenses and income into a spreadsheet is an option, is isn’t the most efficient alternative.

Going from red to black: Tips to improve cash flow

If your business currently has a negative cash flow, it is possible to dig yourself out of the hole. Here are some tactics to help your business ledger go from red to black:

Learn from current cash flow issues

When tracking your cash flow, take any issues forward as lessons learned. Use cash flow takeaways particularly when forecasting your sales.

For example, if a retail business is experiencing cash flow issues because of inventory, the owner can identify opportunities to plan ahead. That may mean forecasting sales for the next busy season and ordering inventory ahead a time. The same applies to slow seasons—if a retailer has tons of products gathering dust on their shelves during specific times of year, plan ahead for your next slow time of year to free up more of your cash flow and prevent product from sitting unsold.

Combat late payments

According to one study, small businesses wait an average of 72 days to get paid. For business owners, waiting more than two months for a paycheck can bottleneck cash flow.

But you can stop chasing overdue invoices with a few simple tactics, including:

  • Invoicing immediately
  • Offering clients multiple payments options
  • Establish late fees for overdue payments
  • Automate payment reminders for clients

For more tips to nix those late payments, read our guide to getting paid on time.

Lean on a line of credit or small business loan

While we certainly don’t recommend that you take on unnecessary debt, small business owners in a pinch can explore credit options with their financial institution.

Entrepreneurs have a few options when it comes to credit for their small business:

  • Short-term business loan: Businesses can take out loans from either traditional banks or online lenders with repayment periods between three and 36 months to provide a quick influx of cash.
  • Line of credit: Similar to a loan, a line of credit offers businesses quick access to money to improve cash flow. A business line of credit is typically more flexible than a loan. While loans require you to borrow a lump sum, with a line of credit, businesses can borrow only what they need.
  • Business credit card: As with personal credit cards, business owners can simply use a card to cover unexpected expenses or provide a cash boost as a stop-gap measure. While high APRs might scare off some business owners, business credit card users can access great rewards like cash back and travel miles.

Cash flow terminology: A brief glossary

While cash flow is a pretty straightforward concept when boiled down to its essence, there are a number of related terms that are worth mentioning. Below, you’ll find a short glossary of related terms with their definitions to serve as a quick reference for you:

  • Cash flow statement: A report that shows all your business account transactions (income and expenses). A statement generally includes three sections: cash from operations, cash from financing, and cash from investing.
  • Cash flow positive: When the amount of cash coming into your business account via revenues and income exceeds your expenses.
  • Free cash flow: This is the cash that’s left over after a business pays all its operating expenses. This is an important metric because it demonstrates how good a business is at generating cash. The basic formula to calculate this is:

Free Cash Flow = Operating Cash Flow – Expenditures

  • Discounted cash flow: This is the process of calculating cash flow using the time value of money and compounding returns.
  • Operating cash flow: This is the amount of cash a business earns from revenues minus the costs of long-term investments or securities. The basic formula for OCF is:

Operating Cash Flow = Net income + Noncash Expenses (Usually Depreciation Expense) + Changes in Working Capital

Moving forward: Integrating positive cash flow tactics into your business

Now that you have a better grasp on the basics of cash flow, you can make more informed decisions to keep your business in the black. Now that you know how to track your spending and income, you can move forward with the necessary steps to ensure your business can grow and achieve a positive cash flow.

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