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Why Cash Flow Matters to Your Business

5 min read • Jan 24, 2022 • Robert Woo

Cash flow is important to your business. But wait, before you stop reading because “duh,” there’s a reason the term cash flow has its own statement report in any accounting software worth its salt. As obvious as the term “cash flow” may seem on the surface, there is more to these two simple words when it comes to the health of your company.

Let’s examine what exactly cash flow is, and why a cash flow statement can act as a barometer of your company’s financial health.

What is Cash Flow?

 

Cash flow refers literally to the flow of cash coming in and going out of your business over a period of time. “Isn’t that what profit is?” you may be asking yourself right now. That’s an extremely common misconception not just because accountants enjoy befuddling busy business owners, but because there is a difference between cash flow and profit.

  • Cash flow is the tangible amount of money going in and out of your business every day. If more is coming in than going out, you have positive cash flow. If it’s the opposite, you have negative cash flow.
  • Profit is the difference between expenses and revenue in a time period. If you made more than you spent, the remainder is called profit. If you spent more, you’re not profitable.

Here’s a simple example. You just received a $10,000 order for widgets from your best customer. You can count that as revenue towards profitability as soon as you book the order, but you won’t get paid until you produce and deliver the widgets, all of which will cost you money. You’re not worried because you know the customer is good for it. But on your cash flow side, the cash inflow won’t be recognized until the money literally hits your business bank account.

In this case, while you’d be profitable because you’ll make more than you spend for your widgets, you’d have negative cash flow on this account until you get paid because you’d be spending money on production and shipping. This means that while you’re not in danger of going out of business, you probably couldn’t make any big purchases until the client pays for their widgets and puts you back in positive cash flow.

A cash flow statement

Instead of compiling all the bank transactions and comparing it to the invoices (which is laborious to read, much less do), bookkeeping software like Lendio’s software connects to your bank account and will be able to chart your cash flow at any given time and over time. The ability to see cash flow trend of your cash flow give you actionable insights into how you handle upcoming expenses and collections.

This is what a snapshot of your cash flow looks like:

 

Cash flow time graph

Displaying your cash flow over a longer period of time helps you see the trends of your cash flow. If it’s trending up with more cash inflow over time, you’re in good shape. 

Keep in mind, your cash flow statement will show you a different side of your accounting than your profit and loss statement. While the latter will show you an expected result of your revenue and expenses, the former will show you the current state of the cash you have on hand and how quickly it is increasing or decreasing.

Additionally, having this statement updated and available can help your business secure financing, as many lenders will want to see your cash flow statement as a barometer of your company’s health.

Here is how to calculate your cash flow:

 

Cash Flow = Cash Balance + Cash Inflows – Cash Outflows

How Cash Flow Measures the Health of Your Business

Positive cash flow is akin to blood pumping through a healthy body. The more positive your cash flow can get, the healthier your company will be. By understanding your cash flow and monitoring how positive or negative it is, you can get actionable insights into your business operations.

Let’s continue with your widget business, which now has negative cash flow due to the payment lag. 

While this was a good business decision because it kept your best customer happy and probably coming back, your cashflow will be showing a major negative until your customer pays you. This means you’re less able to spend money on the things you need because you don’t have it. 

If your cash flow starts dipping into the uncomfortably negative, you can take action by acquiring new customers, charging higher prices on items with more immediate effect on positive cash flow (items customers can buy and pay for in one transaction) or make a more pressing effort to collect on outstanding invoices. And if you’ve tried all this and still feel uncomfortable about your cash flow, you can always look into accounts receivable financing that lets you borrow against future received payments to get through an expensive time or to make payroll.

To better familiarize yourself with operating cash flow, have a look at this piece by contributor Barry Eitel

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Robert Woo: Robert writes on small business growth and entrepreneurship. He is passionate about running his own business. In addition, Robert's also enjoys focusing on helping business owners accomplish their tasks swiftly.

Robert Woo is a freelance writer and marketer who has been running his business with Sunrise by Lendio for more than a decade. He focuses on the tech and finance industry, has been a featured contributor of Lendio, and regularly shares his experience with software via blogs and articles. During any remaining free time, he's obsessing over fantasy football, writing for television, and playing guitar just enough to maintain the calluses on his fingers.