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What is Cash Flow?

Use a Sample Cash Flow Statement

What is cash flow? All business owners need to understand cash inflows and outflows. A cash flow example or sample cash flow statement can help you understand how to handle your cash flow calculation.

Once you better understand the movement of cash in and out of your business, you need to put processes in place to effectively manage it. Many business owners find that cash (or the lack of it) is a significant business constraint; to the degree that it can force business failure if not effectively managed.

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What is cash flow and why is it critical to your business?

Most (okay, all) small businesses encounter cash flow challenges from time to time.

A healthy flow of cash enables your business to pay its bills; a poor cash flow can result in business bankruptcy.

Many business owners are first focused on raising startup financing and operating cash, then, once up and running, they are focused on earning 'enough' profit which, of course, is important, but from a short term perspective, cash flow can be a serious business constraint.

Cash Flow Management

calculate cash flow

Ensure that you understand how to handle cash flow calculations. Use a cash flow example or sample cash flow statement as a model for your own statement.

In today's tight-money/tight-credit environment, a cash flow issue can result in business failure.

Net working capital is also a measure of your business' short term health. Net working capital is the result of current assets minus current liabilities.

Having positive net working capital means that your current assets (cash, accounts receivable, inventory) can cover and pay off short term liabilities; negative net working capital constrains the business; it cannot pay its short term liabilities (such as accounts payable, short term debt, etc.).

The reason that you need to focus on what is cash flow and how can it affect your business is that cash flow statements are used by lenders, investors, suppliers, and other stakeholders as a short term indicator, or measure, of your business' liquidity and solvency.

A good flow of cash enables your business to pay its bills (and keep operating).

Cash Flow Calculation

I've known small business owners who don't track their cash flows at all. Many could not answer the question, 'What is Cash Flow?'. I've also known some owners who track incoming and outgoing cash on post it notes or the back of envelopes; in other words, in a fairly casual process. And then, of course, there are a number of owners who track every dollar in and out accurately, regularly and carefully.

It is also important for all business owners to have an understanding of the financial ratios for their business and whether or not they are operating above or below their industry average.

It's important for all business owners to understand 'what is cash flow' and to learn how to manage it effectively.

Cash incoming from operations (sales revenues and/or investments and/or financing) less the cash outgoing to sustain those operations is a simplified definition of cash flow.

What is Cash Flow Statement? How To Do a Cash Flow Statement? Use a Cash Flow Example.

Generally, preparing cash flow statements can be done by either the direct method or the indirect method.

From a simplified perspective (for specific details, set up your cash flow statement with the help of a certified accountant), preparing a cash flow statement with the direct method involves reporting gross cash receivables and payables by major class.

What is Cash Flow? A Sample Cash Flow Statement (direct method)

Cash Flows From Operating Activities

Cash receivables or receipts from customers.......$25,000

Cash paid to suppliers......................................($8,000)

Cash paid to employees...................................($14,000)

Cash generated from operations.........................$5,000

Interest paid...................................................($1,500)

Income tax.....................................................($1,500)

Net cash flows from operating activities........................$5,000

Cash Flows From Investing Activities

Sale of used equipment.....................................$1,000

Dividends received............................................$2,000

Net cash flows from operating activities.........................$3,000

Cash Flows From Financing Activities

Dividends paid................................................($3,000)

Net Cash flows from financing activities........................($3,000)

Net Increase/Decrease in Cash and Equivalents...............$5,000

Cash (and cash equivalents), beginning of fiscal year.......$2,000

Cash (and cash equivalents), end of fiscal year...............$7,000

Indirect Method: Cash Flow

The indirect method of preparing a cash flow statement uses additions and deductions; it starts with net income, adjusts for all non-cash transactions, and adjusts all cash transactions. Increases in the asset account are subtracted from net income and increases in the liability account are added to net income. The indirect method uses accrual basis net income or loss into cash flow.

On all your cash flow statements, make cash flow notes at the bottom of the statement to reference assumptions, unusual occurrences (one time dividend check, or one time sale of equipment or what the equipment was, etc.). Planned capital expenditures also need to be accounted for in the month and year you plan to purchase. There are a number of cash flow rules to follow to make adjustments for changes. Again, contact a professional accountant to help you with these rules, with cash flow management and working capital management.

Use a Cash Flow Example as a Template

manage cash flow

It is important that small business owners understand what is cash flow and how cash inflows and outflows affect net working capital and affect the business' ability to do business. Use your business financial plan, business operations plan, sales plan, human resources plan,and other plans that have an impact on cash, to build your sample cash flow statement structure.

Each country has its own accounting methods. This is a general discussion related to the impact of cash flow challenges on your small business. Please ensure that you use a certified and/or professional accountant to support your business activities.

Then, make sure that you keep your cash flow statements current and accurate; it will help you understand and plan for cash shortfalls (or windfalls).

Develop a profit maximization plan, using cash flow and working capital as both constraints and opportunities.

Learn to understand 'What is Cash Flow'
and its significance on your business

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Additional Reading:

How to manage working capital?

Understand the importance of the right Startup Financing model for your business.

Business Sale Agreement: Use Business Valuation Tools Before Selling

Business Valuation Methods: Use a Small Business Valuation Formula

Gross Profit Margin Understanding It Will Help You Better Manage Your Business

Return from What is Cash Flow? to Calculate Profit.

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Meeting Financing Challenges

Getting financing for starting up your new business is a challenge.

But just as challenging is ensuring that you have enough financing to operate your business.

Most businesses do not have a steady flow of cash incoming (or outgoing); it comes in 'fits and starts' no matter how much we try to plan for consistency in cash flow.

You need to ensure that you forecast your cash flow needs realistically and that you are on top of your accounts receivable; do not let your customers use you as their bank (by extending long payment terms), especially during the start up years of your business when every dollar is important to your success.

Make sure that you are clear in setting up new customer accounts: tell your customers what you need and expect in terms of payment (for example, cash on delivery (COD), 15 days from date of invoice, a deposit on order and balance on delivery, etc.).

However, also make sure that your invoice terms are competitive for your industry; check out what your competitors offer and make sure that your terms are competitive. For example, if you want payment in a shorter time frame than your competitor offer an incentive for that earlier payment: perhaps a discount of the next order, or a rebate, or a gift.

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Alternative Financing Strategies Include:

  • Merchant 'advances': from companies that lend money on credit card cash flow rather than collateral;

  • Accounts receivables or trade financing: from 'factoring' companies that buy and assume the ownership for the invoice from a customer;

  • Raise money through preferred shares (non voting) or common shares (voting) in your limited company;

  • Subordinate financing: typically a higher interest (because it is higher risk) loan based on cash-flow and receivables, rather than on assets.

For each of these alternatives, talk to your accountant and your banker: even if the banker isn't loaning you the money, they can provide valuable input and advice.