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Cash flow is a critical metric every small business needs to pay attention to. It reveals your company’s financial health in the immediate present by comparing money flowing in and expenses flowing out. While knowing your revenue is obviously important, cash flow shows you how much actual money is moving into and out of your bank accounts.

With some math and some informed conjecture, you can chart the expected cash flow of your business for the future.

Why Is Cash Flow Projection Important?

Cash flow projections, then, predict your cash flow in the future. A cash flow forecast can help you circumvent dreaded cash crunches, which is when your business needs to spend money but there isn’t enough cash on hand to cover the expense. Cash crunches are damaging to any business, and they can be ruinous for young or very small businesses.

Fortunately, with some preparations, you can project your future cash flow and determine how to focus on creating cash flow.

Cash Flow Forecast vs. Projection

No matter what you call your cash flow documents, you should prepare several based on different potential futures. It is a good idea to prepare one cash flow projection based on your present business, as well as a best-case cash flow projection and a worst-case cash flow projection.

How Do You Calculate Cash Flow Projections?

Accounts receivables includes money that is expected to flow into your business, such as sales and payments from client invoices. Grants, rebates, loans, and funding are all considered receivables, too.

Accounts payable is the other side of the equation. Payables include anything your business spends money on: your salary, payroll, inventory, overhead, rent, taxes, and all expenses.

A cash flow statement compares accounts receivables to accounts payable. A cash flow projection predicts your cash flow over time.

To create a cash flow projection, it can be wise to start with the past. Look at 12 months ago and record how much cash was in your bank account—this amount is your starting balance in this example. Break down the past 12 months in terms of receivables and payables. Try to categorize your income and expenses as much as possible to get a better sense of where your money is coming from and what you are spending it on.

For the first month, subtract the total amount of payables from your total receivables. This calculation gives you your cash flow for the month. If it is negative, subtract it from your starting balance. If it is positive, add it to your starting balance. This new balance is the starting balance for the following month.

Repeat these calculations for the entire 12-month span and you’ll have a cash flow chart for your business.

The Small Business Administration has several great templates you can use to make this easier, including a cash flow projection template.

To predict into the future, you can sometimes reuse a lot of the data from the previous 12 months if your business stays stable in that regard. If you know of the specific revenues, funding, and costs that your business will incur in the future, you can use that data, although you should include some contingency spending.

If you are less sure about the future, start with what you know, like rent payments and clients who pay you a specified amount on a repeating basis. Then make educated guesses about what your cash inflows and outflows will be over the next few months. Here is where it makes sense to create several different cash flow projections for your status quo, best-case, and worst-case scenarios.

The time extent of your predictions is up to you, but you should think about your available data. If your company is well-established, you can create projections for many years into the future. If your company is very young, though, it might be more accurate to think in terms of a few months to a year out.

What Is a Cash Flow Projection Example?

Is Positive Cash Flow More Important Than Profit?

You should think about and create forecasts for both profit and cash flow.

How much money are you making?

This is a common and succinct question small business owners often receive, however crass it might seem. The question can feel like a dagger to the heart or a point of pride, depending on how you perceive your business is faring financially.

But how do you know how your business is doing? How do you know if your business is making money or not?

There are 2 main ways to understand the cash coming into your coffers: revenue and profit.

Revenue and profit are 2 systems of defining the money your business is making. Revenue is the top line, and profit is the bottom line.

Let’s explain these concepts, how they interact, and what they mean for your business.

What Is Revenue?

Revenue is the top line because it is all the money your company makes before subtracting any costs.

For many small businesses, especially new ones, revenue is critical. If your revenue is increasing over time, you know there is a demand for your product or services.

However, judging your business’ financial health based on revenue is a bad practice because revenue is too broad of a metric.

For example, suppose an auto dealership decided to severely undercut its competitors by selling new cars for less than it paid for them from the automakers. Revenue would likely skyrocket as consumers discover that its cars are much cheaper than anywhere else. However, the dealership would probably be in deep financial trouble because it would be losing money with every sale.

Still, there are no one-size-fits-all answers about whether revenue or profit should be your focus. In the above example, the dealership might decide the good PR gleaned from the happy customers will be worth more in future sales than the money lost during this price-cutting move.  

What Is Profit?

Revenue is your company’s top line. Then, in your ledger, you subtract various expenses to receive your profit—your bottom line.

Profit usually refers to a positive bottom line. You are then “in the black”—a reference to how accountants commonly color-code their books. If your expenses are greater than your revenues, your profit is negative, although you would probably refer to this figure as a “loss.” Your business would then be “in the red.”

What expenses do you subtract to figure out your profit? There are several methods of computing this number. Gross profit is when you subtract the cost of goods sold (COGS) from your revenue. COGS are the direct expenses associated with each good or service you sell (i.e., the cost of manufacturing or acquiring your goods). This does not include indirect costs, such as rent for your office.

Operating profit subtracts overhead expenses like office rent or marketing from revenue along with COGS. Because of this, it might be a more holistic approach to analyzing your financial situation. There are even more ways to define your profit, like pre-tax profit or net profit.

Your profit margin is how much profit (or loss) you earn (or lose) with each sale; profit margin displays how your profit increases off of your revenue. To determine profit margin, take a version of profit (like gross profit or operating profit) and divide it by your revenue. This will give you the decimal expression of your profit margin percentage.

Is Profit More Important Than Revenue?

“When it comes to investors, there’s a divide,” analyst Andrew Marder of software platform Capterra explains. “In the tech startup world, revenue is often seen as the end-all, be-all of finance. Venture capitalists look for companies that can ramp up revenue regardless of cost, hoping to figure that bit out later on down the line.”

Famously, Amazon, Uber, Zillow, and many other unicorns that define our modern life took decades to turn a profit—some still have yet to be out of the red.

But the circumstances are vastly different between an app startup and a small business in retail, hospitality, or professional services. In most cases, profit is a much more accurate indicator of a company’s financial health.

“In the world of more classic, Warren Buffett-style investing, revenue is almost meaningless,” Marder continued. “These investors—which may also include your business banker—want to see money making it all the way to the bottom of the earnings statement.”

The safest position is to pay continual attention to both revenue and profit—you can’t have any profit without revenue, after all, but you probably want to be spending less money than you are bringing in through sales.

How Do You Gauge Your Business’s Financial Health?

“Looking at your bank account is a bad way to manage your business,” suggests CPA Shabir Ladha. “Many entrepreneurs do it because that’s the only piece of information they have. Having the right bookkeeping or the right information is vital for business health.”

When thinking about your company’s financial wellbeing, you also need to consider expenses, cash flow, and less tangible factors like branding or public perception.

How Do You Increase Profits and Revenue?

Easier said than done! But that is the task of running a small business. With planning and research, you can best chart a path to thrive financially. 

Many solo entrepreneurs and freelancers keep their personal and professional finances combined when they first start out. Any paycheck goes right into their personal bank accounts, and any expenses are charged to their personal credit cards. 

In the beginning, this is understandable. You might not know if your business is going to succeed—or you might start your business as a side hustle, so you don’t think you need a lot of infrastructure. 

However, as soon as your business is established, it’s important to separate your business and professional accounts. Here are a few reasons why—and how to do it. 

You Can File Your Taxes More Easily

Your business can deduct a variety of expenses throughout the year, but you need to keep track of these costs and ensure that they’re separate from your personal accounts. An easy way to do this: open a dedicated business account. You can charge expenses to a business credit card or write out checks that pull from your professional funds.

Once tax season comes along, you won’t have to remember what professional expenses you had. You can simply download your transactions from this account and determine which costs are tax-deductible. This simplifies and speeds up the process. 

You Can Create a Cushion to Keep Paying Yourself

Many freelancers or sole proprietors use their business bank accounts to stabilize their income throughout the year. They deposit all of their income into the business bank account and then withdraw a flat salary each month. 

For example, a contractor might make $7,000 in January and $3,000 in February. By pulling a flat salary, he can afford to pay himself $5,000 monthly (or $4,500 monthly with a cushion saved for later). 

Some people enjoy the stability of knowing they’ll get paid the same amount no matter what they earn. If the business account starts to get too big, these freelancers can award themselves end-of-quarter or end-of-year bonuses and enjoy the extra cash. 

You Can Budget Better

Not only can you enjoy a flat salary with separate personal and professional accounts, but you can also budget your expenses. You can easily see which charges are related to your business and plan for fluctuations throughout the year. 

A common example of these kinds of expenses is professional software subscriptions. A business owner might use a software tool as part of their workflow and pay an annual fee to license it. If the cost of this service is charged each February, the business owner can budget for it and ensure they have enough funds in the bank to prevent overdraft fees. 

You Can Develop Business Credit

If your business begins to do well, you’ll likely want to scale—which will probably require additional funding. To secure this working capital, especially from a lender, you’ll want to have established business credit.

When your personal and business finances are intertwined, you make it difficult to identify your business income and expenses, which are used to assess your business credit. By separating the 2, you can paint a clear picture of the financial health of your business—making it easier to determine your likelihood of defaulting on a loan.

3 Steps to Separate Your Business and Personal Finances

There are multiple ways to prove that your personal and professional finances are separate from each other. Many of these steps are free or affordable for small business owners. 

1. Establish a limited liability corporation (LLC), S-corp, or C-corp. This will give you an employer identification number (EIN) from the IRS to separate your personal and professional business dealings. Most states charge application fees to operate LLCs and require annual reports and payments to stay in operation. Learn what your state charges and budget for it. 
2. Open a business checking account. Once you have your corporation established and EIN generated, you can visit your bank or credit union to open a business checking account. If you already have an existing relationship with the bank, they may be able to waive any opening fees or monthly charges to operate the account. Some banks, however, set limits for how much you need to keep in the account to stay active and above the fee limit.  
3. Take out a business credit card. While you’re at the bank, ask about opening a business credit card attached to the account—some banks offer this as a perk for opening an account with them. You’ll only use this card for business purposes in order to keep your professional and personal costs completely separate. As an alternative for getting your bank’s credit card, look into business cards that offer competitive rewards systems, like cash back or airline miles.  

Once you have your business credit card, you can start to build up your business credit score. This shows that your business can stick to a budget and repay its liabilities in a timely manner.

As mentioned above, most lenders look at business credit when issuing loans, so you may qualify for more favorable terms if you take the time to build up your credit when just starting out. If you lack business credit, then lenders might look at your personal credit scores as well to determine how risky it is to loan money to you. 

Like personal credit, it takes time to build up business credit, so the earlier you start, the better.  

Take Steps to Separate Your Personal and Professional Finances

Even if your business is brand-new, there are steps you can take to keep your personal and professional accounts separate. Start with good documentation and budgeting and then establish a specific bank account and credit process for your business. 

Finally, look into bookkeeping software to invoice customers and record income as it comes in. At Lendio, we offer a free self-service tool for small business owners. This is a great place to set up your ledgers and prepare your business for growth.

The IRS distinguishes different business entities (or statuses) for companies of various sizes and types. The smallest of these entities is the sole proprietorship or a company that is only run by a single person. Learn more about sole proprietorship by reading below.

What Constitutes a Sole Proprietorship? 

A sole proprietorship refers to a person who earns money throughout the year that doesn’t come from investments or income from working at a traditional company. Sole proprietors can also call themselves solopreneurs, self-employed individuals, contractors, and freelancers. 

Do You Have to Fill Out Paperwork to Become a Sole Proprietor?

No. Anyone can start a business as a sole proprietor without registering with the state they live in. However, this does not exempt them from other licensing and education requirements to operate the business. For example, a hairstylist could work as a sole proprietor but would still need a license to cut hair in the state. 

How Do Sole Proprietors Pay Taxes?  

Traditional employers take out a portion of your income to cover federal taxes like Medicare and Social Security. The employee pays half of the required amount, and the employer covers the second half. However, sole proprietors need to pay their taxes on their own. They can directly pay the IRS through quarterly estimated taxes by writing a check or paying online. 

Sole proprietors are responsible for paying both the employer and employee side of federal taxes. However, they can then deduct this income from their taxes when they file each year. 

What Are the Risks of Sole Proprietorship?

There are a few risks with opting for a sole proprietorship over an LLC (limited liability company). The main risk is that your personal and professional accounts can be linked. 

This means if a customer or vendor sues you, they can go after your personal assets like your home and car. An LLC can protect you, but you need to apply for the status and pay annual fees to your state.  

What Are the Benefits of a Sole Proprietorship?

Sole proprietorships are one of the most flexible business entity options out there. You do not have to file paperwork to become an LLC, and you don’t have to answer to shareholders and other owners like a corporation or partnership. Furthermore, all of the profits are yours. 

However, all of the risks and decisions also fall on you. You will need to secure funding, acquire clients, and do the work (except for outside contractors that you work with). If this burden seems too much, consider forming a partnership with another person instead. 

Start Your Business With Organized Books

If you have an exciting business idea, consider becoming a sole proprietor where you can take on a few customers and grow your brand over time. Starting as a sole proprietor can help you decide how to develop your career. 

In the meantime, check out the free tools offered by Lendio to better organize your invoices, expenses, and other ledger items for good bookkeeping within your business.

Documenting your business’s financial status is a fundamental part of running a business, even if it isn’t the most enjoyable. There are a few documents that nearly all businesses, from a beginning freelancer to a Fortune 500 company, should regularly update and study.

Banks, investors, and other lenders will usually require 3 financial documents in making funding decisions: the profit and loss statement, the balance sheet, and the cash flow statement. These 3 data sets are not only the standard reports for rating a company’s financial health externally—they’re also essential for small business owners to truly understand how your company is faring internally.  

1. The Profit and Loss Statement

The business press and investors always eagerly await P&L statements from publicly traded companies because the information is clear, easy to digest, and hard to spin. Similarly, the quick hit of data provided by a P&L statement is incredibly useful for understanding the financials of your company at the moment.

“Small business owners should look at this report at least monthly,” suggests Eric Rosenberg of Due. “It is also a good idea to look at trends, comparing current results to the same period in the prior year and comparing the most recent month with the last few months. This should tell you what’s working well, what isn’t, and help you to focus on the most profitable parts of the business.”

P&L statements are most useful when you can put them into context—this way, you can see how your business is performing over time.

2. The Balance Sheet

There are 3 main components to a balance sheet: assets, liabilities, and shareholders’ equity, also called owners’ equity.

“It shows what your small business owns, owes, and what shareholders have invested in your small business,” Elizabeth Macauley notes in The Hartford’s Small Biz Ahead blog. “This math serves as the foundation of your balance sheet.”

Your assets should equal your liabilities plus owners’ equity. Assets include cash in your bank account, inventory, and real estate, while liabilities most commonly include debts. The owners’ equity equals assets minus liabilities.

“Every balance sheet should balance,” Macauley continues. “You’ll know your sheet is balanced when your equation shows your total assets as being equal to your total liabilities plus shareholders’ equity. If these are not equal, you will want to go through all your numbers again.”

Your balance equation should always be equal if you are doing the math correctly. If your company’s liabilities overwhelm your assets, your owners’ equity can be negative.

3. The Cash Flow Statement

“Cash flow statements are used to evaluate the financial health of a business as well as to provide a full picture of how it spends and invests the money it already has,” Mona Bushnell explained at Business.com.

This statement helps you to understand your cash flow, which is often the lifeblood of any small business—especially new ones. Cash flow is critical, as it dictates how much money you have on hand to cover expenses. If you’re frequently running out of cash due to customers paying late or financial mismanagement, you could soon face a brutal cash crunch.  

4. Accounts Receivable and Accounts Payable Aging Reports

“An aging report is used to show the outstanding customer invoices and the number of days they’ve been outstanding,” the Corporate Finance Institute notes.

On the opposite end, an accounts payable aging report shows what invoices you need to pay and how much time you have left to pay them. Alongside your cash flow statement, you can see how your expenses should be paid over time. 

Accumulated depreciation refers to the total amount of depreciation expenses related to your business. Your business likely has multiple assets that appreciate or depreciate over time. By tracking changes in the value of your assets, you can get a clear view of what your business is worth. Here are a few common questions about accumulated depreciation. 

What Are Some Examples of Depreciating Assets? 

For example, if a restaurant buys a couch for customers to sit on, it will start to depreciate in value as soon as someone sits on it. Stains from spilled food, wear from people sitting on it, and general interior design trend shifts will decrease its resale value. This is no different from the couch in your living room at home. 

Conversely, some assets may increase in value, or appreciate. The most common example of this is real estate. A business might buy a property and pay it off over a decade then significantly profit from selling the space because the land value appreciated. 

What Type of Account Is Accumulated Depreciation?

For example, if you spend $30,000 on a delivery van, you would record that amount under “fleet” in your balance sheet. After a year, the depreciation might be $2,000, meaning the true value of your fleet asset is only $28,000. 

Why Should You Track Depreciation?

Can You Control the Depreciation in Your Assets? 

How Can You Track Deprecation?

Some companies set up formulas for asset tracking. For example, they might reduce an asset’s value by 10% during the first month (because the item is no longer new) and then subtract a percent of the value each quarter. This makes researching accumulated depreciation easier, but it means it’s not always accurate. 

As a business owner, you want your accounting statements to be as accurate as possible to help you make sound financial decisions. Use a tool like Lendio's software to track your expenses and invoices to get a clear view of your company’s finances.

The first thing to know about subsidiary companies is that they can offer tax advantages. In this rocky business environment where financial strain has forced more than a few small businesses to permanently close their doors, any positive tax news should be greeted with open arms.

But before we get into those details, let’s back up and look at what defines these companies. A subsidiary is a company that belongs to a separate company that controls more than half of the subsidiary’s stock. The company holding the controlling interest is known as the parent company (aka the holding company).

Basically, if more than half of your company’s equity is controlled by a separate company, you are likely a subsidiary. In this arrangement, the parent company plays a key role. They help elect the board of directors for the subsidiary and can exert influence on multiple aspects of the business operations.

“Subsidiaries are common in some industries, particularly real estate,” explains a report from The Balance Small Business. “A company that owns real estate and has several properties with apartments for rent may form an overall holding company, with each property as a subsidiary. The rationale for doing this is to protect the assets of the various properties from each other's liabilities. For example, if Company A owns Companies B, C, and D (each a property) and Company D is sued, the other companies can not be held liable for the actions of Company D.”

Now let’s look at some of the tax implications for subsidiaries. Because a subsidiary is a separate legal entity, it must often do all the things that a normal business would. This includes maintaining financial records, recording all liabilities and assets, filing tax returns, and paying income taxes. This level of independence is noteworthy because it opens the door for financial benefits for the parent company. For example, if a parent company in Canada owns a subsidiary based in Germany, the subsidiary might pay taxes on its profits according to the laws of Germany rather than lumping its financials together with the parent company and paying in Canada. This dynamic can often provide tax benefits for the parent company.

Similar tax savings might also be available at the state level. For example, let’s say a parent company in California wanted to use a new trademark. If the trademark taxes were particularly high in the Golden State, the company might create a subsidiary in Wyoming in order to take advantage of that state’s more favorable tax rates.

This is not to say that the financials of subsidiaries and their parent companies are completely separate. There are times when a parent company will consolidate things in order to save money.

“However, many public companies file consolidated financial statements, including the balance sheet and income statement, showing the parent and all subsidiaries combined,” says The Balance Small Business. “And if a parent company owns 80% or more of shares and voting rights for its subsidiaries, it can submit a consolidated income tax return that can take advantage of offsetting the profits of one subsidiary with losses from another. Each subsidiary must consent to being included in this consolidated tax return by filing IRS Form 1122.4.”

While this type of consolidation can be a shrewd approach for a parent company to offset losses among its subsidiaries, special rules apply. Tax returns and financial statements from multiple subsidiaries can only be merged when the parent company owns 80% or more of each of the companies in question. And the parent company would need to notify the IRS in advance of the plan to consolidate tax returns.

As you can imagine, it’s complex and burdensome to manage the accounting for multiple companies. Add in the tax element and things get even more difficult. For this reason, the owners of parent companies and subsidiaries should always invest in the services of a reliable and trusted accountant. Additionally, they should consult with attorneys in order to understand and adhere to all relevant laws.

It’s understandable that some business owners might balk at the idea of paying for accounting and legal help. After all, the price tag is never cheap for quality advice. But it’s a wise investment that will help them maximize the unique financial benefits of their business structure. Failing to do this would be like owning a high-performance sports car but never learning how to shift into its 2 fastest gears.

Subsidiary corporations also need to ensure that their day-to-day bookkeeping is consistent and accurate. It’s a best practice to use bookkeeping software that can automate recurring tasks and help to ensure tax compliance. This proactive approach to your finances will save you time, hassles, and money.

The information provided in this post does not, and is not intended to, constitute tax advice; instead, all information, content, and materials available in this post are for general informational purposes only. Readers of this post should contact their tax professional to obtain advice with respect to any particular tax matter.