Cash Flow 101: What It Is, How to Calculate, & Definitions to Know

Cash Flow 101: What It Is, How to Calculate & Definitions to Know

Cash is the lifeblood of any business, and it’s particularly important for small businesses that may not have huge revenues or reserves. Learning how to manage your cash is a crucial skill that will be a major contributor toward the success or failure of your small business.

What Is Cash Flow?

The movement of money into and out of your business is called cash flow. Cash flow is made up of your cash inflows (money that comes into the business) and outflows (expenditures).

Cash levels ebb and flow according to the operating cycle of your business. This cycle is made up of events that occur in the operations of your business, including:

  • Payments made to you by customers
  • Payments made by you to vendors
  • Capital expenditures
  • Payment of bills for expenses such as rent, tax payments and more

Why You Should Care About Cash Flow

It’s crucial for you to track the cash flow of your business. Cash flow is a primary indicator of the health of your business because it shows whether your business is making enough money to sustain itself — hopefully, you’ll be turning a profit and generating enough revenue to invest and grow. The state of your cash flow should be a big factor in important day-to-day and strategic decisions about the direction of your business.

If you’re unaware of where your business is in your cash flow cycle, you could find yourself unable to pay your bills or fund operations because you don’t have enough cash on hand. Chronic cash flow problems can lead to the failure of your business; in fact, a study by Jessie Hagen of U.S. Bank showed that poor cash flow management contributes to small-business failures 82% of the time.

For seasonal businesses that make a lot of their annual income during certain periods during the year, managing cash flow is particularly important. It takes accurate data and careful planning to make sure your business has enough cash to operate even during periods when not much money is coming in.

When you track your cash flow correctly, you should be able to tell at any point how much cash you have on hand and whether your cash flow is generally trending positive or negative. You should also have an idea of what your future cash flows will look like.

Calculating Your Cash Flow

To calculate your cash flow, you’ll add up your inflows and outflows to arrive at the amount of cash you have on hand. The result of these calculations is your statement of cash flows. This statement should tell you a few things:

  • How much money you have to run your business
  • How much money is moving in and out of your business
  • Where the money is coming from, and where it is going
  • When that money is moving in and out of the business

The statement of cash flows is different from an income or profit and loss statement in that it only includes concrete cash transactions. That means items such as payments owed to your company but not yet collected, depreciation, etc., are not included on a cash-flow statement. It only shows actual inflows and outflows within the specified period of time.

This means that you can have negative cash flow even if you show a profit on your income statement. This is because transactions that are recorded on your income statement as soon as they occur (such as a sale to a customer) don’t show up on a cash flow statement until the payment for that sale is actually received — which might be months after the sale is made.

It’s common to calculate your cash flow statement on a monthly basis, but depending on your situation, you may need to update it more or less often. If you are having cash flow problems, it may be helpful to track your cash flow weekly or even daily.

You may choose to use accounting or financial software to calculate your statement of cash flows, or do it manually.

Formula for Cash Flow Calculation

Stripped down to its essence, calculating cash flow consists of starting with the cash you have on hand, adding any inflows and subtracting any outflows. In other words, a basic cash flow formula is:

Beginning cash balance + cash inflows – cash outflows = ending cash balance

This ending cash balance is the amount of cash you have on hand at the end of the period.

Cash flow is often calculated by breaking your inflows and outflows down into different categories:

  • Operations: Cash generated or spent in day-to-day activities
  • Investing: Cash generated from or used for investing in assets such as equipment or property
  • Financing: Cash generated from loans or other capital contributions or used to pay distributions or dividends

Breaking it down this way, you would calculate the inflows and outflows of each category separately, and then add the net cash (the cash left over) for each category to the beginning balance to get your total cash balance.

In this case, the formula would be:

Beginning cash balance + net operations cash + net investment cash + net financing cash = ending cash balance

Each business will have its own unique inflows and outflows, so you can customize this basic formula for the specifics of your business. SCORE offers a simple template for generating a basic cash flow statement if you need help getting started.

Direct vs. Indirect Cash Flow Methods

The method above, which involves directly adding up inflows and outflows, is known as the direct method of calculating cash flow. The indirect method, on the other hand, uses your business’ income statement. In this method, you use the net income number from your income statement as a starting point, then adjust for items that were used to calculate net income but did not affect cash.

Projecting Future Cash Flows

Along with tracking your cash flow as it happens, it’s also important to calculate your projected future cash flow, ideally at least six months out. You can use your cash flow history to make educated guesses about how your cash is likely to flow in the future.

Using Cash Flow Data to Help Your Business

Knowing your cash flow patterns and projections can help you plan in order to avoid cash flow issues. If you know your cash on hand is likely to be low during a particular period, for example, you might be able to shift major expenditures to other times when you have more cash, take steps to get payments from customers earlier or rearrange other income/spending events to make sure you’ll have enough cash for your needs. You might also look at taking out a loan, getting a credit card or getting another type of cash injection to help your business through a low-cash period.

Cash flow analysis is an invaluable tool that can help your business not only survive, but thrive. For any small business, getting cash flow management right can offer big rewards.

How do you control cash flow? Let us know on Twitter @Revenued_com!

Jennifer Sokolowsky writes about finance, legal and tax topics for publications and companies including The Puget Sound Business Journal, Avalara, and Avvo.
We're working on some pretty cool new pieces of content, including tools that will give you insight into your business finances.

Want to be the first to know when they launch?

Dig Deeper into Cash Flow

Top 5 Best Banks for Small Business

A bit of research into the best banks for small business could wind up saving you significant money — for instance, nearly half of small business owners reportedly pay unnecessary monthly fees. So consider these options as you determine which bank best suits your small business.

Understanding Overdraft Fees for the Top 20 Small Business Banks

You should consider much more than which bank is close by or which one you’re currently using to manage personal accounts. Though there are many reasons to a select a business bank, one of the most important is understanding the bank’s overdraft fee policy.