Understanding cash flow

Understanding cash flow in the time it takes to play a game of solitaire.

In the time that it takes to go through your deck and figure out your game strategy, this article will help you understand what cash flow is and how to write a cash flow statement.

That’s only two minutes of reading time. Ace.

One of the biggest reasons businesses fail is because of “inadequate cash reserves”. That’s just a fancy way of saying they ran out of money.

Making sure you’ve got positive cash flow – meaning you’ve got more money coming into your business than going out of it – is the single biggest factor that will affect your financial health.

Cash flow is all about the liquidity of a business. That is, the amount of money flowing in and out of a business and how much cash you actually have on hand.

The state of your cash flow will change with your business. For example, you probably won’t have much cash flow when you launch your business, as you probably wouldn’t have made many sales.

But as your business grows, keeping on top of the cash coming in and out of your business will become more and more important.


How to write a cash flow statement


Cash flow statements are an overview of money a business has coming in (inflows), and how much it has going out (outflows).

It’s important to write up cash flow statements regularly so you know that there’s enough cash to keep the business functioning.

Cash flow statements are important for many reasons. These include:

  • To make sure business expenses, such as bills and wages, are paid on time
  • To apply for a business loan
  • To convince potential investors to invest in the business

Cash flow statements generally include three main parts:

1. Operating activities

How does your business make money on a day-to-day basis?

The ‘operating activities’ section of your cash flow statement covers how your business makes revenue.

The cash inflows in this section record whenever customers buy your product and services. The cash outflows record your everyday operational costs, such as wages, materials and other expenses.

2. Investing activities

This section of the cash flow statement relates to any long-term investments the business makes. This could include the purchase or sale of property, vehicles or other equipment, which are considered non-current assets.

The investing activities section could also include financial assets, such as securities purchased on the stock market.

3. Financing activities

This section of the cash flow statement includes information about any financial activities your business undertakes. This could include taking out business loans or issuing stocks.

This is also the part of the cash flow statement that records any debt that the business needs to repay.


Managing your cash flow


How you manage your cash flow depends on what your business does and how often you make sales.

For example, businesses that sell many low-cost products and services every day – such as grocery stores – will have inflows every day.
But a construction company that might only do one or two big jobs per year might have bigger chunks of money coming in only a few times per year.

As you can imagine, the cash flow statements of these two businesses would look very different. How they manage their cash flow and put together their statements will also be very different.

We’ve put together some general tips for managing your cash flow, as well as more specific tips for managing cash flow in a business with significant seasonal differences.

Top 3 takeaways

  1. Your cash flow is the amount of money coming in and out of your business.
  2. A cash flow statement helps you keep track of the movement of your business’ money. Update this regularly so you keep on top of your business’ finances.
  3. A cash flow statement includes information about operational activities, investing activities and financial activities.

 

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