Cash Flow Basics: Key Concepts and Terms

Chalk board stock image for Cash Flow Basics Explained

A majority of the businesses around the world are small businesses. According to OECD data, the figure is 99%. Another thing they have in common is cash flow problems. Regardless of whether a business is in an advanced economy, emerging area or somewhere in between, cash flow and cash flow basics are a universal lifeblood and stumbling block.

In the United States alone, most small to medium-sized businesses (SMEs) only have enough cash on hand to cover 27 days of normal costs of doing business. Even the superstars, the top 25% of SMEs only have two months of cash reserves to fund their businesses.

At PayPie, we don’t believe that any SME ever intentionally overlooks its cash flow basics. It’s just matter of finding the right resources to explain the concepts and the best tools to manage financial health.

That’s why we’re providing an overview of some of the basic cash flow concepts and terms. It’s not a glossary so the words won’t be in alphabetical order. Instead, they’ll be grouped by concept in order to add context to each explanation.

Cash flow management is the process of monitoring your cash flow

Cash flow basics 101 — A definition of cash flow 

In its simplest form, cash flow is the amount of money the comes in or out of a company. A primary indicator of financial health, cash flow shows how efficiently a business is running and if that business is able to pay its bills and keep the lights on.

A business that’s cash flow positive has enough money available to meet its current and most-pressing financial obligations. A business that’s cash flow negative has more debt than income and might struggle to meet its financial responsibilities.

There are instances where a company is cash flow negative and is doing so intentionally, such as going through a launch or investment phase. However, in most cases, unless it’s planned or managed, most businesses would prefer to be cash flow positive.

Inflows, outflows and everywhere your cash goes

Income earned through sales, assets that can easily be converted into cash and funding, are called inflows. Cash used to pay for expenses and investments are referred to as outflows.

Some more cash flow basics every business should know are the difference between recurring cash flows and one-time cash flows.

A recurring positive cash flow is a predictable, reliable income source, like retainer or subscription fees billed to customers, while recurring negative cash flow is a consistent expense, like payroll.

A one-time positive cash flow (sit down for this) is a singular influx of cash. One example would be cash from the sale of equipment, land or facilities. A one-time negative cash flow would be a large purchase or expense, such as an insurance deductible for flood damage.

In the same vein, a fixed cost is something like leasing costs for office or retail space. No matter how many widgets you sell, you’re still paying a set rate for your kiosk. This is another shocker: A variable cost changes. These are things like fuel, utilities and raw materials.

Long story short, in most cases, you want your recurring positive cash flows to be greater than you recurring negative cash flows. You also want to be aware of your fixed costs and do as much as you can to control or plan for changes in variable costs.

Get more tips: How to read a cash flow statement.

A cash flow statement explained

There are three fundamental financial statements for tracking and measuring a business’ financial health:

  • Cash flow statement (statement of cash flows)
  • Profit and loss statement (P&L or income statement)
  • Balance sheet (statement of financial worth or net worth)

As per its name, a profit and loss statement compares revenues against costs and expenses to determine if a company is profitable. A balance sheet compares what a business owns to what it owes in order to indicate the amount of working capital, cash reserves available to cover near-term commitments and recurring expenses.

A cash flow statement brings information from the profit and loss statement and balance sheet together by analyzing the flow of cash through the company in terms of day-to-day operations, capital investments and financing activities. (This is one of those cash flow basics to remember.)

  • Operational cash flow literally includes all the nitty gritty expenses (labor, inventory, etc.) that go into making and offering the goods and services a business provides.
    • It also includes accounts receivable and payable (ingoing and outgoing invoices).
    • Current assets and liabilities are two key terms related to this concept.
      • Current assets (counted as part of your inflows) include your cash on hand and any assets that can be quickly sold to generate cash within 12 months.
      • On the flip side, current liabilities (tracked as outflows) are your expenses that must be paid within 12 months.
    • Investment cash flow represents the purchase of long-term assets, like buildings and equipment.
    • Cash flow from financing activities is the money that comes from loans or lines of credit. Depending on your business model, this can also include investors.

Every business financial statement has a specific function. What a cash flow statement does differently is that it helps identify patterns in terms of how and when money is coming into or leaving a business.

Publicly traded corporations have to share their cash flow statements. The average small business doesn’t. Instead, for SMEs, its cash flow basics and measurements are vital financial management tools.

While business models and structures vary, most SMEs will pay the most attention to operational cash flow as part of their cash flow analysis and forecasting.

A cash flow statement combines info from the P&L statement and balance sheet

The direct versus the indirect method of reporting cash flow 

The difference between cash and accrual accounting and how each one calculates net income lies at the heart of the direct and indirect methods for reporting operational cash flow.

Operational cash flow is singled out because it’s the main areas affected by differences in how inflows and outflows are tracked. Warning: It’s a little dry for the next few paragraphs, get ready to skim…

  • Net income is the total amount of money a company has left once all other expenses are taken out.
  • The cash method of accounting tracks income and expenses as they take place.
  • The accrual method includes future income and expenses before they’ve actually hit the company’s books.

Businesses that use cash-based accounting are able to easily use the direct method. This is because they’ve already tracked the actual cash movements in and out of the business as part of the net income.

As most small businesses use the accrual system, the indirect method requires that flow of cash be added back in when net income is entered into the cash flow statement.

When you use the indirect method, you have to account for the actual amounts that come in and out, like accounts receivable (money coming in from customers) and accounts payable (the money you owe to others).

And that’s more detail than you probably ever wanted to know about the direct and indirect method. (So much for just cash flow basics.) Big picture: Whether you scramble or poach your eggs, in the end, you’re still eating eggs.

If you’re curious, when you request a free cash flow forecast from PayPie, we use the indirect method in our calculations.

cash flow basics cash flow management

Cash flow management and monitoring — the basics

One of the cash flow basics that every overview should cover is all the terms that relate to management and monitoring. Cash flow management refers to the entire process of monitoring your cash flow from the creation of cash flow statement to analyzing the results.

The process starts by creating a weekly or monthly cash flow statement. Once the statement is complete, you can perform a cash flow analysis or deep dive on the numbers.

Cash flow forecasting (cash flow projections) are the inferences and predictions drawn from the regular creation and analysis of cash flow statements. A cash flow forecast is a report that contains these interpretations.

Then there’s a cash flow budget that compares the projections in a cash flow forecast with the actual numbers reported in your cash flow statements.

When you bring all these details together to determine how much cash moves in and out of your business and when it happens, you have a cash flow cycle (cash conversion cycle).

It’s sort of like a Russian nesting doll with the cash flow statement as the smallest doll and forecasting and budging being the next sizes up. Each level of detail and analysis builds up to create a larger whole.

Learn more about cash flow and financial health. 

Cash flow versus profitability — what you really need to know

The more you read about cash flow and cash flow basics, the more you’ll see discussions on the difference between cash flow and profitability.

What you need to know is that profitability just means that there’s money coming in. On the other hand, cash flow shows the money coming in and going out. Cash flow helps you determine your break-even point when the amounts coming in equal the amounts going out.

Profitability is only one side of the coin. A business can be making money, but money can also be leaving a company at a rapid or unexpected rate. It happens — more often than anyone would like.

Here’s an example: Jane’s bakery, Cake-and-Bake, is extremely popular. She’s got so many orders, she can barely keep up. Since business is booming, she bought a few more industrial mixers and hired more staff.

What she didn’t do was project was how much cash was coming in from the current and future orders — before buying new equipment and hiring more people. The result: She went too far beyond her break-even point. She found herself low on dough (pun alert) because the cost of the mixers and the new staff members was more than amounts coming in from existing orders.

Short-term liquidity versus long-term solvency  

Liquidity and solvency are often mentioned together, especially in discussions on business financial health. The key takeaway is that liquidity is a short-term measure of your ability to pay your bills.

Solvency is the long-term measure of your ability to keep your company running over time. It’s often used as an indicator of the overall viability of your business model.

Most areas within a cash flow statement and forecast focus on liquidity. This is especially true for operational cash flow, where most of the current assets and liabilities are tracked.

Solvency is often evaluated in terms of debt levels and equity (primarily recorded in cash flow from financing activities). It measures how much ownership the company and its founders have retained in comparison to outstanding loans and/or investor and shareholder agreements.

Take a bow… you’ve just covered some of the basics of cash flow.

It wasn’t that bad, was it? One more concept that’ll change how you see your cash flow basics is automation. You don’t have to build spreadsheets or toil away endlessly to create cash flow forecasts. With PayPie, you can use the information you already have in your accounting software to create easy-to-read cash flow forecasts.*  Learn more and get started today.

*PayPie currently integrates with QuickBooks Online. Additional integrations are coming soon.

This article is for informational purposes only and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional.

 

Image via Pexels.

Cash Flow Forecasting: What You Need to Know

cash flow forecasting stock photo laptop with cash on the keyboard

Every morning at my children’s bus stop, there’s a foolproof way to tell that the bus is about to arrive: When you see a hoard of children running from the park to the bus stop, you know the faithful yellow hardtop is on its way.

Is this child’s play or strategy? I’d say tactical because experience has shown these kids that they have just enough time to get from the park to the bus stop once they’ve seen the bus heading their way. What does this have to do with cash flow forecasting, like a free assessment from PayPie? Everything.

If you pay attention to how and when cash is flowing in and out of your business, you’ll never miss the bus. Or, at the very least, you’ll have a pretty solid idea when the bus is coming, if it’s running late or if you’ll need alternate transportation.

Another reason to watch for the bus known as your cash flow: Nearly 60% of all failed businesses say cash flow was the main reason for their demise.

What’s a cash flow forecast?

A cash flow forecast (cash flow projection) is a report created over time, using information from a business’ cash flow statement (cash flow analysis). Think of it this way: When you have a checking account, you get a monthly statement. If you develop a system for comparing these statements over time, you get a history of your checking account activity. Using this history, you can then make forward-looking predictions.

If you only look at one statement, you’re only getting the details for one specific period of time. It’s like taking a survey of five people instead of 500. When your sample is smaller, your results are less reliable, and cause and effect is much harder to prove or discern.

This is where cash flow forecasting comes into play. Building upon regular cash flow analysis, cash flow forecasting helps you develop a better, more comprehensive picture of your cash flow over time.

“When it comes to liquidity analysis, cash flow information is more reliable than balance sheet or income statement information. Balance sheet data are static — measuring a single point in time — while the income statement contains many arbitrary noncash allocations — for example, pension contributions and depreciation and amortization. In contrast, the cash flow statement records the changes in the other statements.”

— Journal of Accountancy

In the words the pre-Socratic Greek philosopher Ephesus, “The only thing that is constant is change.”

What can a cash flow forecast tell you about your business?

A cash flow statement looks at all the main areas where cash comes in or out of your business. When you pull all this information together and repeat the process over time through cash flow forecasting, you can see:

  • Where your cash comes from:
    • Sales of products and services
    • Sales of assets, like equipment
    • Funding from investors or loans
    • Your own savings
    • Cost-cutting activities
  • Where your cash is going:
    • Production, inventory or labor costs
    • Loan or investor payments
    • Research and development
    • Marketing and advertising
    • Facility or office expenses
  • The timing of when:
    • Bills are due
    • Customers pay you
    • You need to pay your employees
    • You have the highest and lowest levels of cash flow
    • A potential cash flow shortfall could happen

The more you often you complete a cash flow analysis, the more information you have to build your cash flow forecasts and the better perspective you’ll get of how your business is really performing.

Nearly 60% of all failed businesses say cash flow was the main reason.

How can cash flow forecasting help you make smarter business decisions?

Imagine if you didn’t pay attention to your bank account balance and your cash management system was saying a tiny prayer every time you used your debit card. Not the most effective or confidence building method, right?

The same rules apply to the financial health of your business. Having an awareness of how and when money flows in and out of your company through cash flow forecasting, lets you plan and prepare more effectively for:

  • Cash flow surpluses and shortages
  • Current and future tax obligations
  • Labor needs
  • Strategic purchases or initiatives
  • Short- or long-term funding

For seasonal businesses, cash flow forecasting gives you a better idea of how to plan for busy and slow periods. For any business, comparing the numbers in your cash flow statements against your projections will determine just how accurate your predictions are. This can also further pinpoint strengths and weaknesses in a range of areas.

If sales are higher than projected, you can plan to order more product or enhance current features. You might even consider a price increase. On the other hand, if sales are down, you’ll need to figure out what’s happened and why. Before the issue eats away at your cash flow.

Is it time for a sale or special offer? If you’re watching your financials closely, you’ll have a much better idea of what the answer should be.

Read more on how to read a cash flow statement.

What are two areas that get the most scrutiny in a cash flow forecast?

Two areas that get a lot of attention as part of a cash flow forecast and analysis are accounts receivable and accounts payable. This makes sense from a top-down level because accounts receivable is what a business is owed from third parties and accounts payable represents the amount of money a business has to pay to other third parties.

When you monitor your cash flow as a business, you need to be specific about when payments are due versus when you get paid. For instance, you may have several bills due at the start of each month. However, due to you your payment terms, the cash from your customers won’t hit your account until the end of the month.

Two metrics that you’ll want to determine and keep track of over time are:

  • Average collection period — How many days it takes for your customers to pay you.
  • Average days payable — How long it takes you to pay your bills.

Keep in mind that both of these numbers are averages. Some vendors will always take longer to pay and there will always be that one debt that you’ll have to keep whittling down. The norms for your industry will also affect these figures.

It’s all about knowing the patterns. It’s like keeping your personal calendar up to date so that you don’t forget you have a meeting next Tuesday at 3 pm.

Discover the 10 best businesses for cash flow. 

Are there other indicators to look at as part of a cash flow forecast?

Ok, this was a leading question. Of course, there are. Fair warning… there’s math ahead.

Once you’ve started systematically recording your cash flow metrics, you can begin to leverage this data. One way this is done is through ratios — using the relationship between variables to create a new indicator.

It’s “playing” with your numbers, but in a good way — not a burn-the-books-they’re-at-the-door-with-a-warrant sort of way. When you request a free cash flow assessment from PayPie, the following ratios are featured at the top of your report:

  • Cash inflow to cash outflow ratio — Your total cash inflows ÷ total cash outflows indicates the proportion of assets to debts over a set period of time. As you want your inflows to be greater than your outflows, you should aim for a number that’s 1.0 or higher.
  • Current ratio — A current ratio (current assets ÷ current liabilities) shows if you have enough cash to meet your current levels of debt. Ideally, you want this number to be 1.0 to 2.0 or higher, signifying that you have more money than debts. Again, that’s a little simplistic because it all depends on the business, its lifecycle and other factors. For instance, in the early stages, any business might have more debt than income as it’s getting off the ground.
  • Debt-to-equity ratio — Your debt-to-equity ratio (total liabilities ÷ equity) demonstrates how much debt your business carries in relation to every dollar in assets — telling you how much debt is currently affecting your business. In a perfect world, this figure should be 1.0 or lower.
  • Quick ratio — A quick ratio (cash and cash equivalents + short-term investments + accounts receivable ÷ current liabilities) is an “acid test” for liquidity. This is because it includes things, like inventory and accounts receivable, which are considered assets that are easily converted into cash.

Over time as you figure out which metrics to watch, you’ll put together more and more pieces of the cash flow puzzle.

Among SMEs only 12.5 - 57% routinely measure or project their cash flows

When inventory management is integral to your cash flow…

If your business is heavily reliant in inventory as a source of revenue, you will also want to determine an average of how long it takes you to sell or turn over your inventory. The official term for this is days inventory outstanding. In conjunction with this metric, you’ll want to calculate the number of times you deplete or sell all of your inventory per year as well as your cash conversion cycle (average collection period + inventory outstanding – average days payable).

Is there an easy way to automate my cash flow forecasting?

Cash flow forecasting doesn’t have to be time-consuming. With PayPie, you simply connect your accounting software, select the business you’d like to analyze and go.* Our unique algorithms do the rest. Best of all, your highly visual and easy-to-read report is free and you can run your forecast as often as you need — so that your cash flow statements can give you enough history to create long-term projections.

“A cash flow forecast is considered one of the most critical early warning systems for companies that operate with debt, and should be done on a regular basis.” — QuickBooks Resource Center

Is there any margin for error for cash flow forecasting?

As you get into a regular routine of measuring your cash flow statements against your cash flow forecast you’ll start to see the allowable percentage of variance for your business. Should a result skew high or low of this percentage, it’s a sign to take a deeper look and take action.

In most cases, you’re really only able to use your cash flow projections to look ahead about a year. This is because there are some many things that you can’t control, like interest rates, minimum wage increases, fuel costs and other variables.

If my business is profitable, do I need a cash flow forecast?

The short answer is yes. Profitability is just the money coming in from the sale of goods and services. But, it’s only one part of the equation. You can be making money, but if you’re not paying attention to where you’re spending your money, a surplus can evaporate quickly. (More quickly than an unsupervised bowl of candy at a children’s party.)

The customer may always be right. But, cash is always king. Surveys conducted by the Business Development Bank of Canada (BDC) show that among small to medium-sized businesses only 12.5 – 57% routinely measured or projected their cash flows.

If you’ve got enough drive and determination to own your own business, you’ve got the fortitude to take a good hard look at your numbers with cash flow forecasting (shown below).

Ready to get started? Sign up here.

PayPie Cash Flow Forecast Example

*PayPie currently integrates with QuickBooks Online. Additional integrations are coming soon.

This article is intended to be informational only and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional.

Image via Pexels.

10 Best Businesses for Cash Flow

US dollars representing cash flow

The grass is always greener on the other side, right? You have slim margins and so many ups and downs you think you may have whiplash, while your friend’s business seems like it’s printing money. Ever wondered which small to medium-sized businesses (SMEs) really are the best in terms of cash flow? And, is it really easier for anyone else?

Here at PayPie, we wanted to know too. So, we did a little digging. Because there are so many factors that affect the success of any business, we wanted to be as objective as possible, which is why we’ve listed the businesses below in alphabetical order.

You may also see a little crossover as of the industries mentioned can be franchises or home businesses. As you know, in business as is life, nothing is perfect or perfectly black and white.

1. Franchises

Franchises, especially popular, well-recognized ones will pull in cash right from the start. In addition to ready-made brand awareness, the business models have also been perfected to drive sales while controlling costs.

If you’re instantly thinking of workers in uniforms selling french fries, know that owning a franchise doesn’t mean owning a restaurant. While fast food is a mainstay of the franchise industry, there are many options ranging from commercial cleaning and personal fitness to express shipping and financial services.

The initial cost of purchase is the main downside to franchise ownership. Buying a brand-name franchise comes with brand-name pricing. But, once you’ve made your investment, as long as you follow the “playbook” you should be able to sustain a stable cash flow.

2. Finance and insurance

Independent insurance companies and financial advisors enjoy a stable, year-round cash flow, without the extreme seasonal peaks and valleys experienced in other sectors. Insurance brokers and financial advisors require training and certification, but after this outlay, they are able to operate with little overhead.

The insurance and financial products offered by brokers and agents are often produced by third-parties that have invested in the product development and marketing of these items. Some insurance agents and financial advisors also purchase franchises from financial services companies.

3. Health care and social assistance

As Baby Boomers age and enter retirement, there’s a growing market for senior care facilities, nursing homes and rehabilitation centers. Because demand currently outstrips supply in these areas, privately owned business in these categories are able to maintain a strong cash flow, even in the face of significant labor and facility costs.

Want better cash flow? Learn how to read a cash flow statement.

4. Home-based businesses

Low overhead and tons of flexibility? A home-based business might be your best bet. In terms of cash flow, child care and pet care generate consistent returns, especially if you have long-term arrangements with customers.

Project-based home businesses, like event planning or other professional services, require consistent invoice and payment practices. As long as you have a good client base and your pricing high enough, your cash flow will be on solid ground.

5. Niche restaurants

While it’s common to hear cautionary tales of the razor-thin margins for restaurants, localized, independent restaurants, cafes and food trucks are able to buck this trend. They are well-targeted businesses with consistent, loyal customer bases.

Niche restaurants are one area where it pays to be highly specialized. In addition to demand, these owners also have to carefully manage food and labor costs. But, when financing is needed, these businesses also have plenty of access to alternative funding sources.

6. Real estate rental and leasing

Like other businesses on this list, real estate rental and leasing only involve an initial cash outlay. Once you purchase the property, you can then lease it. When leasing at competitive rates, private real estate rental and commercial leasing both provide a stable cash flow.

This is a simplistic overview of a property rental business. Like any other business, operational costs, such as maintenance and administrative costs have to be kept under control. This industry is also susceptible to interest rate hikes that can eat away at profit margins.

See how analytics and insights help improve financial health.

7. Retainer-based professional businesses

Professional services like marketing and advertising agencies, law firms and real estate agencies often based their business on a retainer model. When clients pay a retainer, they agree to pay a set amount, in regular intervals, up front for the services provided.

Because of these stable payment terms, these professionals can better ensure a consistent cash flow. There are interruptions in cash flow when a client either ends their contract or defaults on a payment. However, many of these companies are aware of this risk and take measures to make sure they have a healthy flow mix of clients in the pipeline.

8. Regulated industries

What is a regulated industry? It’s a type of business that’s heavily regulated by the government, including things like oil and gas exploration, utilities and the energy sector. It can also be specific types of manufacturing and transportation, such as making cars or running an airline.

Producing e-cigarettes, a self-driving car or revolutionary new biotech material to help burn victims? This is you too.

Due to the sheer amount of oversight, the businesses that enter these spheres and outperform the limited competition, tend to do well. As do the businesses that work with them. Of course, the key is knowing your industry, complying with the regulation and operating efficiently within your specific business model.

9. Software as a Service (SaaS) companies

Have you noticed that more and more business services are being offered through the cloud? Rather than a meteorological phenomenon, in this case, the cloud means the internet.

Web-based applications are less expensive to produce because they require few raw materials (other than talent, foresight and determination) and they can leverage the existing online infrastructure. Most SaaS applications also use a subscription-based model, which ensures a consistent stream of recurring income. (As long as the pricing is set accordingly.)

If you like to be in the know on industry trends, here’s a fun factoid: By the end of 2017, 94% of SMBs in the United States were using SaaS applications. Some familiar SaaS names include QuickBooks Online, Sage, Xero and other online accounting apps that you can access from your desktop or mobile device.

10. Service businesses

For the purpose of this article, service businesses include more of the trades, as opposed to the professional services listed earlier. This isn’t meant as a slight to the trades, it’s purely for classification and simplification. (Although, some tax laws separate the two as well.)

Like other businesses on this list, in general, service businesses don’t require huge amounts of capital investment to get started. Or, if they do, this only has to happen once or predictably on set timeframe.

Once a service business, like a landscaper, contractor, commercial or domestic cleaners or any other, establishes a solid reputation and loyal customer base, their cash flow is also reliable. In fact, those with the best reputations for quality can often charge slightly higher rates in order to further boost their income.

Here’s one more fact: Personal care services, ranging from massage therapy to any form of wellness or custom services are some of the fastest growing industries based on employment.

What if you aren’t in the top 10 for cash flow?

As you read the list, you probably saw some common factors, like low overhead and steady revenue. If your industry’s not on the list, there’s no reason for doom and gloom. What you can do is take a look at your own operations and see how to create efficiencies.

Another crucial step is monitoring your cash flow. This is where we come in. PayPie offers free cash flow forecasting, created specifically for SMEs. It’s as easy as connecting your accounting software to your PayPie account.* With easy-to-read charts and graphs, you’ll be a cash flow guru in no time.

*PayPie currently integrates with QuickBooks Online. Additional integrations are coming soon.

This article is intended to be informational only and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional.

 

Image via Pexels.

 

 

How to Read a Cash Flow Statement

“cash flow statement

Mark’s technology company was hiring like crazy. Their growth was through the roof. Then the penny dropped. It seemed like it came out of nowhere. A few key clients were late paying their invoices. Suddenly, money was leaving the company faster than it was coming in. Monitoring his cash flow statement had been the furthest thing from his mind, until he experienced his first cash flow crisis.

Sarah’s trucking company was already struggling with rising fuel costs. Then one of her drivers was in a traffic accident and found to be at fault. The deductibles from the insurance were crippling and unexpected. Her family-owned business that she’d taken over from her father was in danger. If she had been watching her cash flow statements more carefully, she could have seen that her cash reserves were dwindling.

Cash flow is one of the main reasons businesses fail. In Wasp Barcode’s 2017 State of Small Business Report, cash flow was one of the top five concerns, cited by 34% of the businesses that were surveyed.

None of these businesses planned to make a mistake by overlooking the importance of a cash flow statement. They were all doing what they thought was best — taking care of business. At PayPie, we make it easier for businesses to take care of business by offering free analytics and insights that include a cash flow forecast.

34% of businesses consider cash flow a top concern

What is a cash flow statement?

A cash flow statement (statement of cash flows) is an analysis that shows how much cash is moving in and out of a business during a given period of time.

One of the “big three” financial statements for any business, a cash flow statement both pulls from and supplements the information in your balance sheet and profit and loss statement (income statement).

A cash flow statement shows how changes in the balance sheet and profit and loss statement affect the inflows and outflows of funds for a business.

What’s included in a cash flow statement?

A cash flow statement is generated from an analysis of the revenues and expenses in three main areas:

  • Operating activitieshow much you made — determined how much cash you made or spent to produce the goods and services you sold.
  • Investing activities — how much you spent — shown by how much cash you used or made through buying or selling capital investments.
  • Financing activities — how much you owe — based on how much cash flowed in and out in relation to business loans or other funding transactions.

The amount of cash a business earns or spends in each of these activities is then summarized into an opening and closing cash balance. The summary of the cash movements from all three activities is the net cash movement or total change in the company’s cash position.

If the closing balance is greater than the opening balance, then you have a positive cash flow. On the other hand, if the closing balance is lower than the opening balance, your cash flow is negative.

If, at this moment, you’re feeling like you’re holding an Allen key and trying to assemble European flat-packed furniture, take a deep breath. The above is a top-level overview. In order to show how each of the activities is broken down and combined to create a cash flow statement, we’ll go through each one below.

Cash flow from operating activities (CFO)

Operating activities are all the functions related to producing or providing a company’s product or service. This includes inventory, accounts receivable, payroll and related taxes, like sales tax.

One of the benefits of examining CFO activities and comparing them to net income is that it shows how well a business managing its operations. If everything is going to plan, your CFO will be positive. A negative CFO could come from any number of inefficiencies ranging from pricing issues to outstanding invoices.

Another reason why CFO is so important is that it’s also the main way that small to midsized businesses finance themselves. In other words, this is where your “spending money” comes from.

Recording CFO in a cash flow statement can be done either by the direct or indirect method.

  • The direct method uses the cash-based system of accounting that only tracks payments that were actually made or received by the business.
  • The indirect method uses the accrual system of accounting where payments are recording before they’re actually received by the company.

If you’re not familiar with accounting methods, here’s what you need to know: Cash-based and accrual are the two most common accounting systems. This also means that both the direct and indirect methods of calculating operational cash flow are valid. Ultimately, the choice comes down to what’s best for your business.

Some businesses choose the direct method because it leaves out non-cash transactions. While other businesses choose the indirect method because they are able to pull numbers directly from their balance sheets and profit and loss statements.

When you run a free financial assessment from PayPie, we use the indirect method to report CFO. You CFO information will also be broken down visually with charts and graphs to help you see the patterns in your numbers.

Cash flow from investing activities (CFI)

The second area, cash flow from investing activities covers purchases or sales of items that are considered long-term investments. Investing activities can include business equipment, buildings or real estate and even securities. Again, a lot depends on your business, your industry, stage of business and other factors.

One of the reasons the inflows and outflows from investing activities are separated out is that many of these purchases are considered capital items. At tax time, large purchases are depreciated over time, meaning you can only claim a certain percentage of the costs over a specific number of years.

Funds invested in purchases are considered outflow and funds made from the sale of investments are inflow.

When reviewing CFI, remember it’s a long-term play and the results are taken into consideration along with other activities. For example, if you’re business is in growth mode, you may be investing in equipment and other capital to help fuel further growth.

Cash flow from financing activities (CFF)

Depending on the size and structure of a business, cash from financing can include the size and payment amounts of business loans or the payment of dividends for incorporated businesses. For startups, this would include fundraising as well as any amounts paid to investors.

Using a small business loan as an example, the money your business receives from the loan is counted as an inflow, while the loan payments are outflows.

A business’ CFF is used as a variable for measuring equity (ownership) as well as lending risk. For example, if you have a lot of debt, but it’s not being used to fuel growth or produce results, you would want to start thinking of ways to pay down the debt. Similarly, an outside business or analyst might also highlight or a high level of debt as a consideration or concern.

Learn another way your company is evaluated in terms of risk.

How often should you run a cash flow statement?

The general consensus is monthly. However, if your cash flow changes quickly or you’re a new business, you may want to consider looking at your cash flow every week.

Once you make creating a cash flow statement a routine part of your financial analysis, you’ll start to build a history of your cash flow. In turn, this will help you identify trends, such as when your cash flow peaks or hits valleys.

The more you learn, the more you’d wish you’d started tracking your cash flow even earlier. It’s sort of like eating your vegetables. Your body needs the nutrition and will be better off for it — even if you have to talk yourself into it the first few times.

Check cash flow monthly

What can a cash flow statement tell you about your business?

By identifying and recognizing patterns in your cash flow through regular analysis, you’ll be better able to predict or prevent challenges, like finding yourself low on cash right before running payroll or experiencing a negative cash flow when an invoice payment (due to your company) is running late.

If you see a cash flow gap coming, you can take measures like finding short- or long-term financing, working with a vendor to see if you can extend a payment timeline or, if necessary, adjusting labor costs.

When your cash flow is positive, you’ll also be in a better position to plan your growth by timing when you choose to act on a strategic decision, like purchasing new equipment, launching a new product or hiring more staff.

Understanding how your cash flow works gives you insights into the financial strength of your business. It tells you where you can improve and where to keep doing exactly what you’re doing.

If you’ve got a handle on your business’ financial health, it will be unmistakable to others wanting to do business with you as well. It’s sort of liking going into a job interview highly prepared rather than just winging it.

Learn how all of your financial statements impact your company’s financial health. 

Is there an easy way to run and read a cash flow statement?

Yes, there is. When you use our free analytics and insights, they include a cash flow analysis. At PayPie, our mission is “To empower businesses by enabling better, more affordable ways to improve financial health.” Offering a complimentary assessment that’s easy to read and understand is simply the first step in the many ways we aim help businesses take control of their finances.

If your company uses QuickBooks Online as its accounting software, you can start right now. Other integrations and innovations are coming soon.

This article is intended to be informational only and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional.

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