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Everything you need to know about cash flow

Do you ever struggle to cover your expenses at month-end because you don’t have enough cash? Understanding “what is cash flow?” is a great start.

If you answered yes to this question, you’re not alone. Many small business owners experience the same problem: They suffer from poor cash flow caused by factors like insufficient client work, slow-paying clients and large unplanned expenses.

But exactly what is cash flow? And why should you even care?

In this post, you’ll learn nearly everything you need to know to help you become a master, including:

  • What it is

  • Why it matters

  • How to calculate it

  • How to track it

  • How to improve it

What Is Cash Flow?

To understand cash flow, begin by learning what it isn’t. Firstly, it’s is not profit. Profit is the difference between revenue and expenses. It’s possible for a business to be unprofitable while having good cash flow and vice versa. This can happen, for example, when a business owner deposits their own money into a bank account, which improves the flow of cash but not profits.

Secondly, it is not working capital. The two are often used interchangeably, but working capital is current assets minus current liabilities. It is the money you can use to fund cash shortages.

So, what is cash flow?

It’s the total amount of money flowing in and out of your business. When more money is flowing in than out, you have positive cash flow and your business is in the black. Conversely, when more money is flowing out than in, you have negative cash flow and your business is in the red.

Changes in the flow of cash usually result from operating, financing and investing activities—although operating activities can often have the largest impact.

Examples of Cash Inflows and Outflows

Let’s look at a few examples of inflows and outflows for these various business activities to help us unpack cash flow a little better:

Operating activities

  • Inflows: money received from clients

  • Outflows: money paid to cover rent, utilities, travel, cell phone and other expenses

External financing

  • Inflows: cash received from a bank loan

  • Outflows: monthly loan repayments

Investing activities

  • Inflows: money received from selling assets like equipment

  • Outflows: money paid to purchase equipment

Why Does Cash Flow Matter?

Cash flow plays a crucial role in:

Keeping your business afloat. You need cash flow to pay the bills and cover the day-to-day, or you risk closing your doors. Your goal is to maintain positive cash flow and ensure you’re always earning more than you’re spending.

Growing your business. A business that’s growing will need enough cash to reinvest—to purchase new equipment, invest in advertising, offices and so on—all while covering costs.

Making smarter business decisions. Knowing your cash flow informs your decisions. For example, let’s say that you plan on buying a new laptop and that at the end of the month you discover your income far outweighs your expenses. You can now confidently make that purchase because you have enough cash.

Conversely, if you’re in the red, you may choose to put that purchase on hold until your situation improves. In either case, you’ve made a smart decision because you’ve been tracking your cash flow.

Seasonal businesses. Seasonal businesses usually have marked slow and busy periods, and unpredictable cash flow. They need to carefully manage their cash flow year-round, so they have enough cash to tide them over during the slow periods.

Better money management. Understanding your flow of cash helps you understand how you’re managing your money and what business activities are leading to increases or decreases in cash flow.

If, for example, you discover you have a profit come year-end but are struggling to cover the bills each month, getting to grips with the inflows and outflows will help pinpoint any problems so you can fix the situation.

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