Cash Flow - How It Works to Keep Your Business Afloat

© The Balance, 2018

What is Cash Flow?

Cash flow is the money that is moving (flowing) in and out of your business in a month. Although it does seem sometimes that cash flow only goes one way - out of the business - it does flow both ways. 

  • Cash is coming in from customers or clients who are buying your products or services. If customers don't pay at the time of purchase, some of your cash flow is coming from collections of accounts receivable.
  • Cash is going out of your business in the form of payments for expenses, like rent or a mortgage, in monthly loan payments, and in payments for taxes and other accounts payable.

Think of 'cash flow' as a picture of your business checking account. If more money is coming in than is going out, you are in a "positive cash flow" situation and you have enough to pay your bills. If more cash is going out than coming in, you are in danger of being overdrawn, and you will need to find money to cover your overdrafts. This is why new businesses typically need working capital, in the form of a loan or line of credit, to cover shortages in cash flow.

Cash vs. Real Cash

For some businesses, like restaurants and some retailers, cash is really cash - currency and paper money. The business takes cash from customers and sometimes pays its bills in cash. Cash businesses have a special issue with keeping track of cash flow, especially since they may not track income unless there are invoices or other paperwork. Cash businesses are more at risk of being ​audited by the IRS

Why Cash Flow is So Important

Lack of cash is one of the biggest reasons small businesses fail. The Small Business Administration says that "inadequate cash reserves" are a top reason startups don't succeed. It's called "running out of money," and it will shut you down faster than anything else. 

Cash Flow When Starting a Business

Dealing with cash flow issues is most difficult when you are starting a business. You have many expenses and money is going out fast. And you may have no sales or customers who are paying you. You will need some other temporary sources of cash, like through a temporary line of credit, to get you going and on to a positive cash flow situation. 

Cash Flow in a Seasonal Business 

Cash flow is particularly important for seasonal businesses - those that have a large fluctuation of business at different times of the year, like holiday businesses and summer businesses. Managing cash flow in this type of business is tricky, but it can be done, with diligence. 

Cash Flow vs. Profit

It's possible for your business to make a profit, but have no cash. How can that happen? The short answer is that profit is an accounting concept, while cash, as noted above, is only the amount in the business checking account. You can have assets, like accounts receivable (money owed to you by customers) but if you can't collect on what's owed, you won't have cash. 

Your accounting system may also show a difference between cash and profits. If your business runs on accrual accounting, you recognize income when the invoice is sent, even though the customer hasn't paid. In this case, you might show a profit but not have the cash. 

How to Analyze Cash Flow

The best way to keep track of cash flow in your business is to run a cash flow report.

A cash flow statement looks at the change to cash (in this case, your business checking account), from different business activities and increases or decreases in other accounts on the business balance sheet. 

For example:

  • What happens to cash if a customer pays a bill? 
  • What happens to cash if your business purchases supplies?
  • What happens to cash if you buy a computer? 
  • What happens to cash if you pay an employee or independent contractor? 

At times, you may need to keep track of cash flow on a weekly, maybe even a daily basis. 

TheBalance suggests: 

 A quick and easy way to perform a cash flow analysis is to compare the total unpaid purchases to the total sales due at the end of each month. If the total unpaid purchases are greater than the total sales due, you'll need to spend more cash than you receive in the next month, indicating a potential cash flow problem.

To dig deeper into this statement: 

1. At the end of this month, look at your total sales.

2. Add up the purchases you have made that still need to be paid for. 

3. The difference is what you will need to bring in as income to stay even. 

If this monthly cash shortage continues for several months, you'll get further and further behind. 

Your accounting software should have a cash flow statement as one of the standard reports, or your accountant can run it for you. Read more about some solutions to cash flow problems.