What is Cash Flow?

If a business can create a positive cash flow (CF), then it’s likely to succeed. But, what exactly is cash flow and how is it different from income? Generally speaking, cash flow can be defined as the “net amount of cash and cash-equivalents being transferred into and out of a business.” The longer a business can maintain levels of positive cash flow, then the better it performs.

When understanding the basics of cash flow as a business owner, it’s good to know that there are different kinds of cash flow.

What are the main kinds of cash flow for businesses?

  1. Operating Activity Cash. This type of cash is created by the day-to-day operations of a business. Money earned from investments, for example, would not be included in this form of cash flow.
  2. Net Change in Cash. You can also look at cash flow as the difference between cash from one account statement period to the next.
  3. Free Cash Flow to Equity (FCFE). This specific type of cash flow is designated FCFE because it’s the cash that can be used to reinvest back into the business. For businesses wanting to grow and scale, FCFE is vital.
  4. Free Cash Flow to Firm (FCFF). Really only used to create financial models or to generate a valuation for a business, FCFF relies on the fact that a company doesn’t have debt that needs to be repaid or that is accruing interest.

What is the difference between income and cash flow?

Cash flow, or CF, determines whether or not your business is succeeding. While income can give you some of the details needed to decide how well your business is doing, only CF can give you a realistic picture. Income only tracks money coming in, not money going out and being spent. That means you can actually make a lot of income while still having negative CF.

The better a business can manage its CF, which means it’s actually making more money than it needs to spend, the brighter its future.

Why should businesses pay attention to CF?

Cash flow is oftentimes the only reason a company goes out of business. When cash is short (or negative), then it’s nearly impossible for a business to continue. According to the SBA, “inadequate cash reserves” is one of the main reasons why new businesses fail. That’s why paying close attention to your CF from day one is critical.

New businesses especially need to manage their CF, which is why having lines of credit or other cash sources are almost always a must.

If you want to better manage your cash flow, then make sure you’re paying attention to these three tips:

  1. Reduce inventory whenever possible. If you have spent too much of your cash on inventory that stays on your shelves too long, then you’re limiting your CF unnecessarily. The more zeroed in you can be on how much inventory you really need, and when you need to re-order, can help keep your CF healthy.
  2. Monitor payments and collections. When services go unpaid it takes a major toll on your business’s cash flow. In order to avoid having money owed unaccounted for, utilize better systems that can keep track of what’s owed and automatically follow up for you.
  3. Think about profit first. A lot of business relationships go on too long, which can really hurt your CF. No matter how much you like working with another person or company, know that it’s time to cut them loose if they can’t manage to pay you on time.

Learn more from other feature courses

Learn more about eCommerce