Cash flow is the flow of cash coming in and out of your business. When your customers pay you, and money comes into your business, it is called cash inflow. When you pay your suppliers to buy the product or service, money goes out of your business, called cash outflow.
This combination of cash inflow and outflow is called Cash flow.
In this article, I share with you the basic understanding of cash flow you need to know as a small business owner.
Why would you trust me?
As a cash flow specialist for the last two decades, I have helped hundreds of clients with their cash flow challenges. I have been featured on this topic on major sites like QuickBooks Online, Independent, Zoho, and Floatapp.
I review my client’s cash flow statements and devise a plan of action to fuel long-term growth. I do this all day, every day, for a living. So, don’t worry. You are in safe hands.
Let’s dive in.
Key Takeaways
- Cash Flow Journey Mastery: There is a reason why cash flow is called cash flow, because cash flows in the business. It’s a journey. Understanding the journey cash flow from making a sale to hitting your personal bank account. Spotting where cash gets consumed the most is key to solving money worries.
- Pro-active Cash Flow Strategy: You need to regularly review cash flow statements. It’s an ongoing effort essential for financial health, not a one-time task. Routine drives results.
- Customize Cash flow Model To Fit In To Your Business Model: You should be aware of how your specific business type (cash or credit) impacts your cash flow. Adjust your approach to measure, manage, and maximize cash flow. Do it to fit your unique needs for better financial control.
What are the Examples Of Cash Flow?
Cash flow is divided into two areas: cash inflow and cash outflow.
Let me share examples section by section with you.
Example of Cash inflow
Here are some examples of cash inflow:
- Government grants
- Cash received from sales
- Financing loans
- Business owner investment
Example of cash outflow
Here are some examples of cash outflow:
- Payment to direct suppliers and paying costs towards sales (also known as variable costs)
- Payment towards indirect suppliers and fixed expenses)
- Taxes to pay like PAYE, NI, VAT and corporation tax.
- Loan repayments
- Shareholder payments in the form of dividends
Understanding How Cash Flow Works
You need to know three areas to understand how cash flow works.
Cash flow diagram- Journey of Cash Flow In A Business
Let me share with you the cash flow diagram.
I have simplified the flow of cash. There are five stops cash has to go through to reach your personal bank account from your business.
I call it a cash flow journey.
When I go to Manchester from London, the train goes through five stops before reaching my destination.
In the same way, cash flow has to go through FIVE stops in your business before it reaches the ultimate destination, your personal bank account.
Let me take you through each of these five steps.
The first stop comes when you make the sale and collect the payment from your customer.
Then, you pay suppliers who supplied what went into making the product or service you sold. At this point, you arrive at the second stop, called Gross Profit. It is the cash left after the costs of fulfillment.
Then, you pay for fixed costs like rent, salaries, and office expenses. You pay for these costs whether you make a sale or not. After paying for fixed costs, you arrive at the third stop in the cash flow journey, profit before tax.
Next, you pay business tax to arrive at the fourth stop in your cash flow journey.
After that, you pay personal tax to arrive at the fifth and final stop in your cash flow journey.
This is when cash flows to your personal bank account as INCOME in your bank account.
At each stops of cash flow journey, cash balance tells you cash used at each stops. By knowing these steps, you can fix the cash flow problems at the exact stop that needs attention to avoid a situation of lack of cash flow.
What Is Not Included In Cash Flow?
Here are some non-cash expenses that are not included in cash flow.
- Depreciation expense
- Amortization
- Stock write-downs
Now you know what cash flow is, it’s time to learn about what cash flow indicates.
What Does Cash Flow Tell About Financial Health?
Cash Flow tells you into three areas :
- Liquidity – Cash flow tells if the company can handle expenses without problems. When a business can cover expenses with its cash flow, it runs smoothly. The usual expenses covered by cash flow are rent, rates, salaries, marketing, professional fees, and office expenses.
- Solvency– Cash flow indicates whether a company has sufficient cash to cover long-term financial obligations.
- Free Cash Flow– Free Cash Flow is surplus. The company can use it for reinvestment or dividends.
What are the common cash flow misconceptions of business owners?
I have worked with entrepreneurs and small business owners. Here are five common cash flow misconceptions.
- Profit and cash flow are the same- “If my business is profitable, then I have positive cash flow.”
- Revenue growth implies a healthy business
- Looking at cash flow is a one-off exercise
- All customers are good for cash flow
- Having a cash flow cushion is not required in a stable business
In my work, I see small business owners and entrepreneurs make a big mistake. They confuse cash flow and profit.
If you fall into this category, check out cash flow vs profit.
Why Is Cash Flow Important to You as a Small Business Owner?
Never take your eyes off the cash flow because it's the lifeblood of business.
You may have come across this quote from Sir Richard Branson.
Cash flow is like oxygen in your body.
It’s like petrol in your car; without it, the car doesn’t move forward.
From my experience, I have worked with businesses in different sectors for the last two decades. I am a chartered certified accountant and cash flow expert. There are mainly ten reasons why cash flow is important to you.
These ten reasons cover daily cash flow issues. They also cover monthly and quarterly financial decisions. They are to monitor, manage, and maximize cash. These areas cover:
- STABILITY: Ensuring business generates positive cash flow to meet your short-term financial obligations.
- SUSTAINABILITY: Build a strong cash flow defence to sustain high cash flow pressure in different economies. This defence avoids negative cash flow.
- SCALING: Identify free cash flow cash flow to fuel business growth faster.
If you want to go deeper on this topic, you can check out the importance of cash flow.
What are the Differences between Cash Business And Credit Business ?
Your business model has an impact on cash flow.
There are two types.
- Cash collection at Point Of Sale (POS) (Cash Business)
- Cash collection normally after 30 days (Credit Business)
Let’s explore this in more detail.
1. Cash flow Business- Cash collection at the Point Of Sale
If you are in hospitality, retail, or dentistry, you get cash when the sale happens. So it’s a cash flow business.
Cash Flow Businesses Operate On A Cash Basis Rather Than On Credit.
Another example of a cash flow business is one that collects cash first and pays later.
One of my past clients sells luxury sofas. He collects the payments from the customers first. Then, he pays the suppliers who make the sofa. So, this business is a cash flow business.
2. Credit Business- Cash collection normally after 30 days
You might not get paid for 30 days from your invoice date if you are a coach or consultant or run marketing agencies. It works on a credit basis and is not a cash-flow business.
Yes, some coaches would charge upfront cash. But most send their invoices after they do the work. Their clients pay in 30 days.
Such a business is a credit business, not a cash flow business.
Why does this matter?
In my opinion, it is one of the best cash flow business models. It reduces the risk of cash flow crunch. The business only has to pay vendors if they have a business from customers. They use future cash inflow to cover future cash outflow. This leaves the current cash flow in the business intact and available to re-invest.
What are the three types of Cash Flows?
There are three types of cash flows you need to be aware of:
- Operating Cash Flow
- Investing Cash Flow
- Financing Cash Flow
1. Operating Cash Flow
Operating cash flow is generated from cash flow from operations. It is the main source of cash to operate the business.
Cash-rich businesses generate positive net cash flow and hardly rely on external funding.
Cash-strapped businesses’ working capital is always challenged. Their net flow of cash is mostly negative. Statement of cash flows shows poor cash collection, and money coming in is far less than money going out.
So, if you want to build an uber-profitable, cash-rich business, you must get a complete handle on operating cash flow.
2. Investing cash flow
it’s generated from cash flow from investing activities. Businesses need to make investments for three reasons:
- To support business growth, such as buying new capital equipment, hiring employees,
- Investing for return at a future date. Such as buying another business, properties etc.
- To remain competitive in the market.
3. Financing Cash Flow
Financing cash flow is generated from cash flow from financing activities.
Most businesses can’t rely on organic funding, meaning cash from operations. Their cash may be tied up in buying investments, capital expenditures, and receivables. So, they have to either :
- Take out business loans from the lender to fund the business operations. Loan providers receive interest payments, which means cash outflow for the business.
- Issue equity to investors. Businesses will be paying dividends to the investors as shareholders in future, which means money will go out of the business.
This is what financing cash flow means.
What Are The Areas Of Cash Flow You Need to be familiar to get on top of cash flow ?
As a business owner, these are the main topics you should be aware of if you want to secure financial stability and grow your business sustainably.
1. Cash Management- Managing Cash Flow Like a Boss
According to score.org, 82% of businesses fail because of poor cash flow management.
If you want to be in the winning part of the 18% statistics, you need to manage your cash flow.
You can check out the cash management topic in detail
2. Cash Flow Analysis- Reading Cash Flow Statement like a finance pro
Have you ever experienced driving a vehicle with foggy eyeglasses? You can’t see what’s in front of you, right?
That’s what happens when you run your business without being able to do a cash flow analysis.
Here’s the thing
I believe what you don’t know and can’t see are the two biggest killers of the business.
Being able to read your company’s financial statements is key. They include the income statement, balance sheet, and statement of cash flows. They let you assess your business’s finances
3. Measuring Cash flow Metrics and KPIs that Matter to you
Just like you wouldn’t drive a car without checking on the dashboard, you shouldn’t run your business without measuring metrics.
Having said that, do not get confused between metrics and KPIs.
While metrics indicate what are the metrics you need to hit to reach your financial goal, KPIs cover how to get there.
I cover cash flow metrics and KPIs in detail. You can check it out.
4. Projecting Cash Flow to make crucial long-term cash flow decisions, taking your business to the next level
Projecting cash flow is one of the financial skills you need to master. You project cash flow to see how you are going fund your business to achieve long-term financial goals.
If finance is not your passion, then get a cash flow expert in your corner. It will pay you dividends for the years to come.
How?
Cash Flow expert will guide you to make crucial money decisions.
I remember one of my dental multiple seven figures client asked me, should I buy another dental practice?
Guess what we did?
We worked together for 18 months preparing periodic cash flow projection. After 18 months, he bought a new dental practice.
5. Forecasting Cash Flow to make immediate cash flow decisions, ensuring financial stability
You want to regularly prepare a cash flow forecast to identify immediate or short-term money shortages.
Cash flow forecasting lets you find out how much money a business needs. It needs to cover payroll, rent, and the survival of a business owner for a specified time.
6. Access to the statement of cash flows on a real-time basic
Your cash flow statement is like a mark sheet of your cash performance- Shishir Khadka
It tells you how well you have performed in the three areas of cash flow: operating, investing and financing.
To do this, you need to have access to cash flow statements regularly to identify cash flow gaps and excess cash to re-invest.
7. Understand the cash flow drivers -what affects your cash flow
Cash Flow drivers are the components of the financial statements that affect cash flow.
Did you know ten cash drivers affect cash flow?
Some components are taken from profit and loss statement for example: sales price, sales volume, costs, and expenses.
We take some components from the balance sheet. These include inventories, accounts receivable, accounts payable, taxes, drawings, and capital investments.
As a business owner, you should know these to understand which levers to pull when.
If you want to go deeper on the topic of cash flow drivers, I have a dedicated section to cover it comprehensively.
8. Cash Flow Calculation
Cash calculation is a process of knowing where you are cash flow-wise for a specific situation. This can be to :
- measure a specific marketing campaign
- measure specific cash collection from a particular product
- measure which platforms are providing better cash flow ROI.
You get the picture. It can be anything.
To do this, you need a cash flow calculator, and you can check out the one I have created.
9. Dealing With Cash Flow Problems
From my experience working with small business owners based in the UK, I have seen all businesses go through cash flow problems at some point. These cash flow problems might be temporary hiccups or continuous month after month. They might be at a small scale affecting the business’s liquidity or could be bigger, affecting its solvency.
Either way, cash flow challenges and problems are most common.
Especially after COVID-19, we have witnessed how many businesses closed because they lacked funds to sustain them.
If you are worried about your situation, don’t worry, I’ve got you covered.
You can check out cash flow problems in the cash flow centre.
10. Determine cash flow improvement strategies that apply to your specific situation.
Every business wants to improve cash flow. The question is, how to do it? There is no one-size-fits-all solution to this.
Having said that, if cash flow improvement is your concern right now, you can tap into 27 ways to improve cash flow in your business right now guide.
11. Evaluate different cash flow models and methods that work well with your business model.
I have seen this working with hundreds of clients across various sectors over the last two decades. Every business is unique, even if they operate in the same sector.
Therefore, the cash flow model you choose as a tracking system must be customised to your specific needs.
12. Building customised cash flow templates to streamline preparing cash flow statements
We talked about preparing cash flow statements. To do this, you need cash flow templates.
From what I have seen, templates can speed up preparing cash flow reports and reduce the risk of errors and omissions.
In addition, you can customise the template to suit your specific needs, understanding, and layouts. Etc.
In the cash flow template section of the cash flow centre, I share with you templates. I have created and customised them for various sectors and business sizes. You can check it out. There is bound to be the one you are looking for if you already do not have one.
13. Being aware of cash flow tools and software that can speed up the amount of cash collection
A spreadsheet or Google Sheets is fine if your business is small and you only need a basic solution assessing cash position.
As your business grows, so do your business activities. It means there are more transactions to deal with.
From what I have seen, managing cash flow in a spreadsheet might not be a good move if you are growing a business. Spreadsheets are prone to errors and take a lot of time.
This is where cash flow software comes into play. You should connect cash flow software to your accounting software. This will save the hassle of making accurate, timely cash flow statements.
Being familiar with these topics allows you to be aware of three areas as a business owner.
- How do you monitor what’s happening to your cash position? – I call it cash flow clarity
- How do you manage cash flow ?- I call it cash flow Control.
- How do you maximise cash flow to support your business growth?- I call it cash flow creation
Let’s go through them briefly.
Cash Flow Clarity
Cash flow clarity means being self-aware of your cash position. In other words, it means being able to read cash flow statements. Understand your cash position. It will help you find cash leakage. This creates consistent positive cash flow to reinvest in your business.
This is the fundamental point of mastering cash flow. Check out the cash flow clarity guide if you want to go deeper on this.
Cash Flow Control
Cash Flow control means having complete control of your cash flow.
Here’s what I believe.
Cash control = control in your business.
Most entrepreneurs and small business owners are overwhelmed. They are stressed about financial stability due to cash flow problems. If you are facing similar issues, I recommend you check out the cash flow control guide.
Cash Flow Creation
Cash flow creation implies improving cash flow from three distinct areas of cash flow.
- Cash Flow From Operations (CFO)
- Cash Flow From Investing Activities (CFI)
- Cash Flow From Financing Activities (CFF)
Here’s the problem I see often.
Don’t make this classic mistake most entrepreneurs make of only concentrating on one of the areas only.
From my work with entrepreneurs and small business owners, most rely on the CFO to run the business.
It reminds me of one of my clients; when I started to work with this company, the business was doing £2.75m in revenue a year and a net income of £557k. This business had consistent positive cash flow year on year over seven years in its business journey.
I showed the owner that he could have used a loan instead of investing cash from a business. It would have saved time getting to the level of business he was at.
To create steady positive cash flow to boost your cash, check out the cash flow guide.
If you prefer to watch rather than read, here’s the video for you.
Summary
In this guide, we looked at what cash flow is. We covered why it’s important and how it works in business. We also covered some nuances you need to know to understand it.
I know the term cash flow can be heavy for some of us when we start small, especially for those who have been riding a cash flow rollercoaster for a long time.
My goal is to help you understand cash flow from the basics to the advanced level so you are not left behind.
I will leave you with a question: which area of cash flow do you need to master the most and why ?
Let me know, by leaving comments below.
