A business’ success is not always accurate gauged by its profitability. In fact, a better way to assess whether a business is financially sound is to check its cash flow. So, let’s understand business cash flow a little better.
What is Business Cash Flow?
Business cash flow is the money that flows in and out of a business every month. Despite the fact that it may feel like money only seems to flow out most of the time, there is actually an inward flow of money too.
Therefore, business cash can flow in when customers and clients buy your product or service. It is not necessary for your customers to pay at the time of purchase, and if this happens, then the cash flow comes in in the form of accounts receivables.
Business cash flows out when you make payments on expenses such as rent, mortgages, monthly payments, taxes and other types of accounts payables.
At the end of the day, if you have more money coming in than going out, then you have a positive cash flow. If, however, you have money going out than coming in, then you have a negative cash flow and are in danger of being overdrawn.
Why is Cash Flow Important in a Business?
There are many reasons why keeping track of your cash flow is extremely important. Here are some key reasons why:
- You can use your cash flow statement to assess whether you can afford to expand or not.
- Your stockholders can analyze your cash flow statement to understand whether your business has enough money to pay out dividends.
- Suppliers look at your cash flow statement to see if your business can afford to pay your debts if they extend you a line of credit.
- Investors will check your business cash flow to assess the possibilities of future growth.
Cash Flow Statement
Every business needs to prepare a cash flow statement. This way you know how much money is being spent and how much is coming back into the business.
There are three basic activities that business cash flow (inflow as well as outflow) tracks – investing, operations and financing.
- Investing: These activities include all transactions that lead to the future income generation. This includes things like spending money on equipment, land or buildings you need to run your business, cash used to buy equity, or even cash advances paid out to suppliers or customers. There are times when investing could lead to a negative cash flow, but that isn’t always a bad thing.
- Operations: This includes cash that is used for day-to-day operations like sales, production and distribution. Operating activities usually comprise the biggest source of income for your business. Cash received from sales, royalties, fees, commissions as well as money spent on advertising, paying suppliers, wages, and so on are all business cash flows from operations.
- Financing: This measures the flow of cash coming in from your financiers such as banks as well as stakeholders. These cash flow activities include money given or paid to investors, money received for the sale of shares and/or debt, cash spent on dividends paid out, share repurchases, as well as cash paid out for notes, bonds, and even mortgages.
Managing your business cash flow is critical not just to its survival, but also its growth. Your overall target should be to have a positive cash flow, while ensuring that you also strategically use that cash to invest in the growth of your business.
Make it a point to analyze your cash flow statement every month so that you know exactly where your money is going and how much is coming in at any given point in time.