108 Greenwich St., 5th Fl New York, NY 10006
For personal assistance, call
877-880-8086
Get Started

The simplest description of cash flow is the amount of money moving into and out of a business within a period. For most businesses, cash flow is tracked during a month, but cash businesses may prefer daily or weekly options. When running a business, this is one of the most important metrics to keep an eye on because it dictates the financial performance of the business and perhaps even its survival. Therefore, you must consider this just as much as you think about profitability. 

What then is a positive cash flow?

A business is considered to have positive cash flow when the money coming into the business is more than that going out. Money coming into the business is what you get paid for your products and services. At the same time, the money will be leaving the business in the form of bills, expenses like rent and salaries, possible loan repayments and even taxes. If the money coming in is more than that going out, that business is considered cash flow positive, and vice versa.

How does this compare to profitability?

Because this money is used to keep the business running, you have to maintain a balance in cash flow and lean toward being cash flow positive. But what’s tricky is that cash flow is very different from profit and this can sometimes trip you up. Consider the example of Tom who runs an online business selling hand-made apparel on their website.

Every month they buy raw materials worth $10,000 and spend another $5,000 on other expenses like rent, storage, shipping, etc.. In return, they make sales worth $20,000, leaving a profit of $5,000, which is pretty decent. By the end of January, some funds have still not been processed by the credit card company and some payments are still pending. When calculating for profit, though, these pending payments are counted as accounts receivable and factored in. However, for calculating cash flow, only completed payments are considered as money flowing into the business.

If, say, there is still $6,000 in pending payments, the cash flow in this situation would be negative – $14,000 in sales – ($10,000 + $5,000 in expenses) = -$1,000

To understand cash flow, it’s best to think about it as the difference in the balance of your business bank account between the end and start of the month; or a week, if that is your cash flow period. On the other hand, profit is an accounting principle that works on an accrual basis. That is why profit is counted as soon as an invoice is sent to the customers, even if they are yet to pay. In the above example of Tom’s business, Tom’s business still made a $5,000 profit in January because profit was calculated as soon a product was shipped and a sale made. 

How to determine if you are cash flow positive

Looking at this example, you can see that a business can have negative cash flow and still claim to be in profit. Running a negative cash flow for one or two months is not uncommon due to delays, but keep doing it for several months and then you start having problems. Because cash flow is used to pay for expenses and raw materials, negative cash flow may stall your business. This is why whenever a business is in trouble, accountants and other finance professionals will focus more on the cash flow than the profitability to identify problems in the company. 

When you want to find out if your business has a positive cash flow, you need to create a cash flow report. The first entry to the report indicates all the cash you have in hand at the beginning of the month. In most cases, this is the balance on your business bank account. Check your bank statement for the balance left after your last transaction from the previous month. If you have multiple business accounts, make sure to include all of them to the first entry.

Now get to the body of the report that indicates the cash inflows and outflows. Cash inflows include all the cash received within that month from your customers while cash outflows include all the cash spent during that month. Since this is a cash flow report, only include actual cash transactions that happened that month. Going back to Tom’s example, if he sent an invoice for $1,000 in January but expects to be paid in February, this is not counted as a cash inflow in January. At the same time, if he paid for some expenses on the company credit card and doesn’t pay it back in January, this isn’t included in the cash outflow section either. 

In the end, you should have two columns with varying numbers and the difference determines if you are cash flow positive. Cash inflows are listed in the same column as the bank balance from the previous month, so add all these up. In the second column, add up all the expenses for the month. If the cash inflow is higher than the outflows, then your business is cash flow positive. 

How does positive cash flow affect your business?

By now you must already see the benefits of cash flow, and the most important one is to inform you about the financial health of your business. Even more important to your business is that you can use the findings to come up with a cash flow projection. Most business owners prepare for the future by working with a budget, which is just an estimate and guesswork of future income and expenses. However, cash flow projections are a lot more accurate and reliable, which can prepare you for the future even better. 

With positive cash flow, uncertainties about the future also disappear as you can predict future events. Consider a business that operates in a kind of cycle around the year with peak seasons at certain times of the year. Knowing this, you will know on which months you may need to order more raw materials in anticipation of higher demand. Therefore, you will be less likely to become overwhelmed by an increased number of orders in particular seasons. At the same time, you will be prepared for those seasons when cash inflow is low so that you can come up with cash for expenses. 

In the same way financial professionals value positive cash flow, so do creditors and lenders. When you go to ask for a line of credit or a loan from the bank, they will ask to see your cash flow report. This will show them how much money your business receives compared to how much is spent to determine if you have enough left to pay back the loan. Obviously, positive cash flow will lend you more credibility with lenders and you’re much more likely to get that loan, and at a more favorable rate. 

Finally, positive cash flow determines if your business is ready to grow and by how much. If you only focus on the profit, it may show you an attractive figure, but without the actual cash in hand, no advances can be made. But when you do know you have a certain amount of cash in hand, then you can plan for growth. In cases of negative cash flow, you will be informed earlier and plan how to cut your expenses until the cash flow shifts the other side.

What to remember about cash flow

The worst thing you can do is sit comfortably simply because you have a positive cash flow and secure for the future. Cash flow should be used as a tool for improvement, so constantly take time to make changes that favor your business in the long-term until you achieve your goals.