What is cash flow?
Cash flow and accounting

What is cash flow?

Cash flow is a critical part of any business. It's also a term that can confuse many people just getting started in business. This is why we're going to dive into the world of cash flow and explain what it is, why it's important, and how you can forecast your own cash flow.

What is cash flow?

Cash flow is the amount of money a business has to pay its bills. Cash flow is not a measure of profitability or liquidity - but rather, it's the difference between cash coming in and cash going out.

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For example, if your company earned $70,000 in revenue this month and paid $30,000 for overhead expenses such as salaries and supplies, then your net income would be $40,000 ($70k – $30k). But what happens when you factor in things like taxes? What happens if you have some debt payments due? To determine how much money you have available to keep the lights on and pay employees every week (or month), we use cash flow calculations instead of profit numbers alone.

Why is cash flow important in business?

Cash flow means that you have enough money coming in to keep your business running; and, more importantly, growing. The opposite is true if a business has negative cash flow: it can't pay its bills and may even go out of business.

Cash flow is the difference between profit and loss for any given period of time (usually monthly). Profit measures how much revenue was generated by sales or services rendered, while loss looks at how much it cost the company to produce those products or render those services. Cash flow takes both of these numbers into account: it measures what comes in from customers minus what goes out for expenses. It's an important tool because it shows whether or not your business is making money; keeping track of this figure over time can help predict future success or failure, depending on whether cash flows are positive or negative.

What is a cash flow statement?

A cash flow statement is a financial statement that describes a business's cash inflows and outflows over time. It shows the net cash flow for the period, which you can use to help you make decisions about your company's future. It's also known as the statement of cash flows.

You may hear people refer to "cash flow" in other ways, though they aren’t all exactly the same:

  • Working capital
  • Liquid assets
  • Profitability 
  • Liquidity

What's the difference between working capital and cash flow?

It's important to understand the difference between working capital and cash flow. The two terms are often used interchangeably, but they aren't exactly the same thing. Both working capital and cash flow are essential to small businesses because they help you know whether you can afford to expand or make major purchases without having to turn to a lending institution like a bank for financing first.

Working capital is defined as the difference between current assets and current liabilities. Cash flow is defined as the difference between cash in and cash out—in other words; it's how much money comes into your business minus how much goes out.

Here's an example: if you buy $500 worth of inventory from a supplier and receive it immediately, that transaction will be recorded as an expense (cost of goods sold) and will reduce your working capital by $500 immediately. If you sell that same inventory for $1,000 after three months of storage costs, however, then only $500 will be recorded as gross profit when you sell it — but once again it will reduce your working capital by $500 immediately because that's how much it cost you originally.

Cash flow is a more comprehensive measure than working capital because it takes into account both inflows and outflows of cash over a period of time, typically one year. For example, if a company has $100 in revenue in January but hasn't paid its suppliers yet, then its cash flow will be negative even though its balance sheet shows $100 in cash on hand at the end of January.

How to forecast cash flow

Forecasting cash flow is an essential part of running a small business. If you're using a standard accounting software like MYOB or Xero, it can often automatically calculate your forecasted figures for you. But knowing how to manually forecast your business's cash flow gives you the freedom to plan for unexpected expenses and opportunities, as well as helping you make better decisions about what areas of your business need more funding and where you can afford to spend less.

Cash flow is calculated by subtracting all operating expenses from total revenue. For example, if a company earns $100,000 in revenue and pays $20,000 in operating expenses, its cash flow is $80,000 ($100,000 - $20,000). This number represents how much money a business has left over after paying its bills — or how much cash it has on hand. ​

Of course, this is a fairly simple measure of cashflow - for a comprehensive view, look outside the box. Examine trends; look for trends in sales and expenses over time to help predict what the future holds for your company. For example, if sales have historically increased during the summer months and decreased during the winter months, then you can expect that trend to continue into the future.

You can also consider seasonal or cyclical fluctuations in your industry and region of operation. For example, if you operate a retail store, then it makes sense to expect higher sales during certain times of year (such as winter holidays) than others.

Xero’s forecasting template can help you make predictions about how much money will be available to your business in the future.

How to free up cash flow 

Cash flow management is one tool that can help you maintain an adequate working capital position. Here are some tips:

Pay your suppliers promptly when possible — it's important that you pay your suppliers promptly so they don't charge you late fees or interest charges on overdue accounts receivable balances. The longer it takes you to pay your bills, the higher your overall cost of doing business will be because late fees can add up quickly over time.

Keep track of all transactions — as with any financial management tool, proper bookkeeping is essential for effective cash flow management because it helps ensure that all transactions are recorded accurately and timely so that you know exactly where your money is.

Cash flow is critical to any business, and understanding it can help your business succeed.

Cash flow is the movement of cash into and out of a business. It's the fuel that keeps your company running and helps you make decisions about how to grow in the future.

Cash flow is critical to every aspect of business, but it often gets overlooked because it can be challenging to measure. However, understanding cash flow can help you make better decisions that will benefit your small business in the long run.

By monitoring how much money is coming into your business and where it's headed, you'll be able to understand how healthy your company really is—and what changes need to be made in order for it not only survive but thrive as well!

The importance of cash flow

A business's cash flow is a critical part of its success, and it's important to understand how it works. Cash flow can be affected by many different factors, including sales volume and customer payment patterns. By forecasting your cash flow and making adjustments as needed, you can ensure that your business stays on track for success.

Disclaimer: always refer to professional advice. The information presented here is purely indicative and not intended as advice. Always consult a legal or finance professional.

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