February 02, 2016

What is cash flow and why is it important?

Bookkeeping-101

What is cash flow and why is it important?

Keeping track of cash flow is critical for every business owner in every industry.

What is it? The basic concept is easy to understand. A cash flow is a movement of cash into or out of your business. Net cash flow equals the total amount of cash flowing in minus the total amount of cash flowing out.

Why is it important? If your business has positive cash flow, there’s more cash coming in to your business than cash going out. With positive cash flow, you’ll be able to pay expenses, save for the future, reinvest in your business, return money to shareholders, and settle debts. A business with negative cash flow is losing cash and might not be able to do those things.

Is negative net cash flow always bad? Not necessarily. Losing money in the short term might be okay if it helps you make money in the long term. Growing companies that are hiring a lot of people or making other investments (such as large purchases of goods or equipment) sometimes have a negative cash flow. That’s not a bad thing if the investments pay off. It is very common for early-stage startups to have negative cash flow, sometimes for more than a year.

Why should I worry about negative net cash flow? With negative cash flow, your company will be limited in its ability to pay for what it needs, settle debts, and invest in the future. Long term negative cash flow typically leads to insolvency. 

What’s the difference between net cash flow and net income? Net income is the difference between your revenue and expenses. This includes all money owed to your company, whether or not the payments have actually been received. Cash flow does not include money owed but not paid to your company.

What are the categories of cash flows? Cash flows are often divided into three categories:

1. Operating cash flows: This is the cash that your business gains or loses in day-to-day operations.

2. Investing cash flows: This is cash gained or lost on long-term investments that a company has made, such as buying or selling a new plant or equipment, or investments in securities.

3. Financing cash flows: This is cash gained or lost as a result of raising capital and repaying investors and creditors. Your net cash flow from financing activities might be negative if you are servicing debt, retiring debt, or paying cash dividends.

If net cash flow in one category is negative, you’ll have to make up for it by generating positive cash flow in another category. For example, if your operational cash flow is negative, you’ll have to generate positive cash flow from investing (e.g. by selling assets) or financing activities (e.g. by taking on new debt).

Have questions about how to measure cash flow for your business? Contact Jesse Gildesgame at jesseg@bookstime.com for a free consultation.

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