Cash flow is the heartbeat of your business. When it stops, your business flatlines. Did you know that 82% of businesses that fail do so because of poor cash flow management? That's according to Jessie Hagen of US Bank.
Think of this as a crash course in business anatomy. First, we’ll break down what cash flow is and how to read a cash flow statement. Then, we’ll dive into the nuts and bolts of managing your cash flow and the remedies you can apply if your business is feeling financially sick.
What is Cash Flow?
Cash flow is like the fuel in your business engine. It’s the measure of money flowing in and out of your business over a set period. Positive cash flow means more money is coming in than going out. Simple, right? You’re able to pay your bills, cover expenses, and keep things running smoothly.
Negative cash flow? That’s a red flag. It means more money is leaving your business than entering, making it tough to cover payments and keep operations afloat. This concept of having enough cash to meet your financial obligations is what we call working capital. Think of it as your business's safety net.
Cash Flow vs. Revenue
Let’s clear up a common confusion: cash flow vs. revenue.
Revenue is your business's income—straightforward, right? It’s the money rolling in from sales, services, or any other activities. But here’s the kicker: it doesn’t tell the whole story.
Cash flow? That’s the complete picture. It measures not just the money coming in but also what's going out. It includes every dollar spent on operating expenses, investments, and even financing activities. Did the bank just drop a $10,000 loan into your account? Yep, that’s part of your cash flow.
Understanding the difference is crucial. Revenue might look great on paper, but if your cash flow is negative, you’re in trouble.
Why Does Cash Flow Matter?
There’s a famous saying in business: “Revenue is vanity, profit is sanity, cash is reality.”
In plain terms, your financial management starts and ends with cash. If you don’t have cash on hand for your business needs, you hit roadblocks—fast. Managing your cash flow means knowing when you’ll have cash, figuring out how to get more of it quickly, and controlling your spending so you don’t run into problems.
Mastering cash flow management is the cornerstone of managing your business finances. Once you’ve got that nailed, you can focus on growth, improving margins, and boosting profit. It’s the foundation for scaling your business to new heights.
Cash Accounting vs. Accrual Accounting
Here’s where things get interesting: cash accounting vs. accrual accounting.
If your business uses the cash accounting method, your books will mirror the actual cash in your business pretty closely. Simple and straightforward.
But if you use the accrual accounting method, measuring your cash flow becomes doubly important. Why? Because accrual accounting is a long-term, big-picture way of understanding your finances.
Imagine you run a design agency. You just completed two massive projects for a client. The work is done, and you’ve sent the invoices. With accrual accounting, you record that revenue the moment the invoice goes out, even if it takes the client six months to pay. Your books show revenue, but your bank account? Not so much.
This discrepancy is why understanding cash flow is critical. It ensures you know the real-time financial health of your business, beyond what the books might suggest.
How to Manage Cash Flow
Want to get a grip on your cash flow? Follow these seven steps:
Stay on Top of Bookkeeping Bookkeeping isn’t just busy work. It’s the best way to understand every financial transaction in your business. You can’t do the rest without it.
Generate Cash Flow Statements If you have an accountant, they can handle this. Otherwise, use software or a trusty spreadsheet. For extra credit, create cash flow projections to see how your decisions impact future finances.
Analyze Your Cash Flow Use the data from your cash flow statements to understand how money moves through your business. Knowledge is power.
Determine if You Need to Increase Cash Flow Relying on credit cards or lines of credit to make ends meet? That’s a red flag. You need more cash flow. Free it up.
Cut Unnecessary Spending Overspending can kill your cash flow. Identify unnecessary expenses or poor timing in your payments. Cut the fat.
Speed Up Accounts Receivable Waiting on client payments or deposits? The faster you get money in your pocket, the healthier your cash flow.
Rinse and Repeat Make cash flow analysis a regular part of your routine. The more you do it, the better you’ll get at spotting opportunities to boost cash flow and avoid shortages.
Cash Flow in Action
Let’s bring cash flow to life with a simple example. Imagine you own a small bakery. You’ve just landed a big order to supply a local cafe with 500 cupcakes, and you’ve sent them an invoice for $1,000.
Now, you want to buy ingredients to fulfill the order, which will cost you $400. You also need to pay your assistant baker $200 and cover your monthly rent of $300.
That’s a total of $900 in expenses. Your $1,000 invoice should cover it easily, right?
Wrong. The cafe won’t pay the invoice for another 30 days, and until then, you don’t have the cash in hand to cover your immediate expenses. You’ve got a cash flow problem—great revenue on paper, but no liquidity to keep your business running smoothly.
Most small businesses face similar cash flow issues. That’s why cash flow statements are crucial. They help you see the real picture of your financial health and plan accordingly.
Cash Flow Statements
Keeping an eye on your cash flow is crucial, and cash flow statements are your best friend for this task. These statements are one of the three essential financial documents you need for running your business—the other two being income statements and balance sheets.
A cash flow statement’s main job is to show where your cash has moved during a specific reporting period.
Here’s an example:
Cool Table. What Does It Mean?
Alright, let’s break it down. We’re talking about three key sections of a company’s cash flow to understand its financial health. Let’s use our fictional business, “Rodeo Rentals,” as an example.
Cash Flow from Operations: This is the money flowing in and out related to Rodeo Rentals’ main gig—renting and servicing mechanical bulls. 🐂
Cash Flow from Investing: This involves money moving due to buying and selling assets. For Rodeo Rentals, it’s all about purchasing new equipment. 🛠️
Cash Flow from Financing: This tracks money from loans or lines of credit. It’s the cash moving in and out from financing activities. 💰
Think of these sections as envelopes where your cash gets sorted.
Your income statements and balance sheets show the money across different accounts, even if the cash isn’t there yet. Cash flow statements flip that script and show the actual movement of cash.
For instance, “Accounts Receivable” tracks money owed to you. If you peek at Rodeo Rentals’ income statement for July, you’ll see $3,000 invoiced to clients—hence the “Increase in Accounts Receivable.”
But here’s the kicker: the cash isn’t in the bank yet. So the cash flow statement takes that $3,000 and shows it as ($3,000). It’s pulling that amount out of Accounts Receivable.
In accounting, black numbers mean cash is added. Numbers in brackets or red mean cash is subtracted. That’s why being “in the black” is a good thing.
The Indirect vs. Direct Method
When it comes to generating cash flow statements, you’ve got two methods to choose from: the indirect method and the direct method.
Most small- and medium-sized businesses go with the indirect method. Why? Because it’s straightforward. You start with your net income for a period and adjust it to see how much cash you’ve actually got on hand. It’s quick and gets the job done. Rodeo Rentals uses this method.
The direct method, on the other hand, is more common with larger businesses. This approach means listing all your cash income and expenses for the period. You need to dive deep into your financial records, separating what was paid with cash and what wasn’t. It’s more time-consuming but gives a detailed picture of your cash movements.
How to Get Cash Flow Statements
Got balance sheets and income statements on hand? You can try crunching the numbers yourself to create your own cash flow statement. But if you want to save time and avoid headaches, there are easier options:
Use Accounting Software
Accounting software can generate cash flow statements for you. Just remember, the accuracy of these statements depends on the accuracy of the data you input. Prices vary across different software suites or cloud-based services.
Hire a Bookkeeper
A bookkeeper can charge anywhere from $20 to $50 per hour. They’ll use your transaction history to generate cash flow statements—and other financial reports—for your business.
Let JNG Bookkeeping Do It for You
Your JNG Bookkeeping team will handle your bookkeeping every month and create cash flow statements for you upon request. Save time, reduce stress, and get accurate financial insights without lifting a finger.
How to Calculate Your Operating Cash Flow (OCF)
Cash flow statements are the best tool for analyzing your business's cash flow, but calculating your Operating Cash Flow (OCF)—also known as cash flow from operations—gives you a quick snapshot of the cash you have to work with.
Here’s the simple formula:
OCF = Total Revenue – Operating Expenses
Let’s break it down:
Total Revenue: This is all the money that has flowed into your bank account from accounts receivable, direct sales, or a mix of both. Important: Total revenue does not include income from investments.
Operating Expenses: These are all the costs you’ve incurred to keep your business running and produce your products or services.
Imagine you’re calculating cash flow for the prior month. Your total revenue is $50,000, and your operating expenses are $30,000.
So, your OCF is:
OCF = $50,000 – $30,000 = $20,000
This $20,000 is the cash you have available to reinvest in your business, pay off debts, or stash away for future needs.
Calculating OCF isn’t just about preventing overdrafts. Track it over time to see if it’s increasing or decreasing, and use that insight to make strategic decisions.
Remember, unlike cash flow statements, OCF won’t show you exactly where your money is coming from or going. It’s a quick overview, not a detailed map.
Managing Cash Flow
Let’s switch gears to our new example. Imagine you run a successful mechanical bull rental and servicing business, “Rodeo Rentals,” dominating the market in Oregon. Business is booming.
But your accountant, Nicki, has been on your case lately. She insists you need to spend more time on “cash flow analysis” instead of just tossing your statements into a filing cabinet. According to Nicki, cash flow is the lifeblood of small businesses—neglect it, and things could quickly go south.
Here’s what you can do with your statements to manage cash flow effectively:
Make Sure There’s Enough Cash on Hand
Let’s look at Rodeo Rentals’ cash flow statement for September.
Even though net income was decent, cash flow was tight—just $1,000 to work with. What went wrong?
The owner was feeling confident after invoicing clients for $8,000 (Increase in Accounts Receivable). Money was on the way, so he thought it was time to splurge. There was an end-of-summer sale on novelty cowboy hats, and he spent $7,000 (Increase in Inventory) on hats to include as prizes with his mechanical bull rentals.
The catch? Even with $7,000 worth of cowboy hats sitting in the garage, that’s $7,000 he can’t use elsewhere. And despite having $8,000 in Accounts Receivable, the cash hasn’t hit the bank yet. That’s why the cash flow for the month is just $1,000.
Fortunately, by examining the cash flow statement, he can see what’s up and adjust his strategy. Next time sequined Stetsons go on sale, he might think twice before letting Accounts Receivable burn a hole in his pocket.
Tracking How You’ve Spent Your Money
After the cowboy hat fiasco, the owner of Rodeo Rentals decides to dig through past cash flow statements to understand his spending habits better.
His income statement for April shows lower revenue than usual, so he checks the cash flow statement for more insight. Here’s what he finds: A significant chunk of his cash flow—$7,000 out of a total of $13,000—came from an increase in Accounts Payable. Curious, he digs into his transaction records and discovers he hired a bunch of contract workers to run mechanical bulls at a three-day “indoor rodeo” event.
The verdict? The event had more cash outflow (paying contractors) than cash inflow (ticket sales). Lesson learned: Next year, when the indoor rodeo rolls into town, he’ll keep expenses in check and avoid overextending his cash flow.
Keeping an Eye on Accounts Receivable
Still hung up on the cowboy hat debacle, the owner of Rodeo Rentals revisits the September cash flow statement.
That’s $8,000 tied up in Accounts Receivable—money he didn’t have on hand to splurge on glittery hats. Maybe the issue isn’t his penchant for flashy cowboy gear; maybe it’s his clients' slow payments.
He dives into his records to check the Increase in Accounts Receivable for his busy summer months:
August: $7,000
July: $3,000
June: $8,000
May: $9,000
Except for a few time-sensitive clients who paid early in July, he spent most of the summer waiting for money to hit his account. Now he sees the pattern and realizes he needs to take concrete steps to get paid faster.
Tracking Debt Payments
Rodeo Rentals’ cash flow statement includes a section called Cash Flow from Financing. This section reveals how much debt is costing the business every month in the form of Notes Payable.
For September, Notes Payable was $2,000. Looking back at previous months—August, July, June, and May—the amount has stayed steady at $2,000.
When the owner logs into his online banking, he sees that the minimum monthly payment on his small business loan is $1,500. So, he’s contributing an extra $500 each month to pay down his debt.
Business has been good, so he decides it's time to accelerate his loan payments. He schedules a meeting with his accountant to create a more aggressive repayment plan.
How to Improve Your Cash Flow
Maybe reading about the sequined Stetson spending spree brought back tough memories for you. He wasn’t quite at $0 cash flow, but he came close. Have you ever gone to pay for a business expense and found you didn’t have the cash to cover it?
That’s a sign of poor cash flow—also known as lacking liquidity. Fortunately, there are steps you can take to increase liquidity and avoid cash shortfalls.
Increase Revenue
It sounds simple, but the more money coming into your business, the more cash you have to cover expenses. Here are the four ways to boost revenue:
Increase the Number of Customers
Increase the Average Sale Amount
Increase Purchase Frequency
Raise Prices
Instead of asking, “How can I increase revenue?” try asking, “How can I get more customers?” Breaking the problem down into these categories makes it manageable and actionable.
Reduce Overhead
Cutting operating costs is another straightforward strategy. Reduce your Cost of Goods Sold (COGS) or Cost of Services (COS) to grow your bottom line and free up cash.
Strategies include finding cheaper vendors, living with less, buying in bulk, or joining a buying cooperative. Each step helps reduce expenses.
Manage Your Inventory Carefully
Cash tied up in inventory is cash you can’t use elsewhere, but you need enough inventory to avoid stockouts. If cash flow is tight, consider running a sale to convert surplus inventory into cash quickly.
Effective inventory management is crucial and can be influenced by business growth, marketing plans, seasonality, and vendor prices.
Match Receivables to Payables
Syncing up your Accounts Receivable with Accounts Payable helps ensure you have the cash you need when you need it. For example, if your loan repayments are due on the 15th but your clients typically pay at the end of the month, you may face cash shortfalls. Adjust invoice due dates or payment schedules to align better with your financial obligations.
Speed Up Your Invoice Cycle
The faster you get paid, the quicker you can cover expenses. Here are a few ways to speed up payments:
Shorter Payment Terms: Reduce the payment period from 60 days to 30 days.
More Payment Options: Accept credit cards to expedite payments.
Early Payment Incentives: Offer discounts for early payments.
Invoice Factoring: Sell invoices to a third party for immediate cash.
Pay Off Debts Faster
Paying down debt reduces future interest payments, freeing up cash each month. Prioritize paying off chunks of debt when business is booming to benefit long-term.
Check for prepayment penalties before making early payments to avoid offsetting potential savings.
Sell Your Assets
Liquid assets are easier to convert to cash. In a cash flow crisis, consider selling non-essential assets. For example, if Rodeo Rentals needed immediate cash, they could sell one of their vintage mechanical bulls on eBay.
Refinance Your Debt
Refinancing can reduce monthly debt payments. For instance, taking a small business loan at a lower APR to pay off high-interest credit card debt can improve monthly cash flow.
Your accountant can assist in finding refinancing options that work for your business.
This post is for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult their own attorney, business advisor, or tax advisor regarding the matters referenced in this post. JNG Bookkeeping assumes no liability for actions taken in reliance upon the information contained herein.
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