Get to the Basics of Cash Flow

“Cash is king”—this timeless adage couldn’t ring truer for investors. Cash is the lifeblood of any business. Without enough of it on hand to run your operations, you’re bound to go under. For most companies, cash flow is the difference between success and failure, profit or loss.

Cash flow is an especially vital statistic for small businesses because they typically don’t have much in the way of financial resources. If they can’t manage their day-to-day revenue and expenses efficiently enough to generate positive cash flow every month (i.e., more money coming in than going out), they won’t stay afloat long without a steady infusion of capital from somewhere outside the company.

In other words, if you own the next Starbucks, you’re going to need more than just a good idea and an experienced manager – you’re going to need money.

Cash flow is different from net income. Cash flow considers depreciation, an accounting non-cash expense you can think of as the wearing out of assets over time. Depreciation expense isn’t included in your net income figure because it doesn’t require using up any cash.

What Is Positive and Negative Cash Flow?

Let’s say your business brought in £100,000 last year and spent £90,000 during that same period. Though your income statement will show £10,000 in profit (assuming you don’t have any other accounts on your books), it doesn’t mean much if cash isn’t coming into the bank account at a healthy rate.

This is where positive cash flow comes into play. It measures how quickly incoming revenue turns into actual “cash in hand” that can be used for whatever purpose management sees fit. These can include paying bills, investing back into the company, etc.

On the other hand, a negative cash flow (also known as negative net operating cash flow) arises when incoming revenue fails to cover outgoing expenses. More money is leaving the company than entering it.

If this continues for too long without any sign of improvement, the company could face serious financial problems like having its utilities shut off or not being able to pay employees’ salaries. Having deep pockets (or access to capital) will prevent most companies from falling into this situation in the first place. Failing that, loans might be the only solution left.

calculating cashflow

How to Calculate Cash Flow

Simply put, cash flow is the difference between the money your company has coming in and what it’s spending. To calculate, take all incoming payments (e.g., accounts receivable) and subtract all outgoing expenses (e.g., accounts payable).

The resulting figure represents how much cash your business generated over a given period. It can be one month or a year. It’s also referred to as net operating cash flow.

How to Increase Cash Flow

While your business definitely needs to generate income, knowing your cash flow still matters for the following reasons:

  • Your income shows only a fraction of the financial health of the business. In other words, it doesn’t tell the whole story.
  • The business income is useless if you are spending it at a much faster rate.
  • Knowing your cash flow position helps you find ways to improve it.

One of the best ways to increase the cash flow is to reduce expenses – everything from shipping costs to payroll hours. This process starts with analyzing which areas of the business are bleeding money.

You can then take steps to tighten up or eliminate resources costing too much without adding proportionate value. For instance, if your company spends thousands every year on supplies alone (such as printer paper), consider investing in bulk deliveries rather than single packages at higher prices.

Your machinery and equipment cost a lot of money, from depreciation to maintenance. Your business can choose to sell them to boost your cash flow (provided doing so won’t make your company less productive) or maximize enhanced capital allowances to lower your tax liability and offset spending on these pieces of equipment.

If you can’t find any way to cut costs without negatively impacting your company’s bottom line, then you’ll need to increase revenue to see a positive cash flow.

One of the easiest ways is with price increases or new service fees, especially if those changes affect only a certain segment of customers willing (and able) to pay more. Just be sure that these adjustments will generate enough income before deciding whether it’s worth making them.

Businesses often have trouble finding a balance between their income and expenses because they don’t have a strong grasp of their financial situation, making it difficult to control. However, if you can get a handle on how much money is coming in and going out, you’ll be able to make well-informed decisions about your business’s future.


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