Cash Flow 101

Cash flow is the term used to describe changes in how much money your business has from one point to another. Cash flow management is the process of keeping track of this flow and analyzing any changes to it. This helps you spot trends, prepare for the future, and tackle any problems with your cash flow. Net cash flow (cash receipts minus cash expenses) is an important measure of financial health for any business. According to a study performed by Jessie Hagen of U.S. Bank, 82 percent of businesses fail because of poor management of cash flow.  

Start-up or small businesses often find it difficult to generate and hold onto cash. This is usually due to the debt incurred and the cash needed to fund operations and pay off debts. An understanding of free cash flow, liquidity, cash budgeting and the relationship between cash and profit is critical to success.

Free cash flow is the amount of cash a business generates after accounting for cash generated from operating, money spent on fixed assets (capital expenditures) and shareholder payments, if any.  Essentially, free cash is the cash you have leftover to do something with.

Liquidity is basically the company’s ability to pay its short-term debt. Several ratios help determine liquidity. First, measure current assets against current liabilities. Assets include cash, accounts receivable and inventory.


Liabilities are bills you owe within 90 days. Next, determine if you can pay your short-term debt or current liabilities without having to sell any inventory. Third, analyze your accounts receivable turnover. Identify the amount of time it takes each one of your customers to pay. Next, calculate the average number of days it takes to sell your goods or services on credit, and then collect payment. Finally, prepare monthly cash budgets. The purpose of a cash budget is not to set targets, but to anticipate needs and address what-if scenarios. 

Cash flow and profit are not the same. Financial accounting, one of the three main types of accounting, is not focused on cash flow. It focuses on net income or profit. While profit and cash flow are related in that profit is part of your cash flow, and it is what is left over after paying your obligations, it doesn’t identify your liquidity.


For example, when you make a sale to a credit customer, you recognize that sale immediately in your accounts. You enter a debit for your inventory and a credit for your receivables. But, you may not receive cash immediately. According to your accounts, you have made a profit. However, you do not have the cash for the sale yet.

As you can see, the gap between profit and cash flow could be very large. If you have rapid growth in credit sales, for example, profit could far exceed cash received. For small businesses, the most important aspect of cash flow management is avoiding extended cash shortages caused by an overly large gap between cash inflows and outflows. 

The bottom line to good cash management is keeping yourself informed. Develop an understanding of how your cash flows in your business, and create a cash budget to give you a healthy cash balance. A good business banker can be invaluable in assisting you with this process and analyzing your data.


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