Finance

What Exactly Is Cash Flow (And Why Do We Need It?)

Did you know there are over 128.6 million businesses in the United States? If you’re about to open or run your own business, then you must learn all of the important concepts to be successful. And, one of the most important concepts is cash flow.

Sadly, many people don’t know what this term means. Or, they confuse it with something else, like profit. So, exactly what is cash flow? If you want to learn the answer to this question and more, then you’re in the right place.

In this article, we’ll go over everything you need to know about cash flow. That way, you can prioritize it in your business. Let’s get started!

What is Cash Flow?

Source: pexels.com

All too often cash flow is confused with other concepts like profit. As such, let’s start with some definitions.

Cash flow refers to the net amount of money that is moving both in and out of a business.

This is distinctly different from profit which is the difference between your revenue and your expenses. The cash that your business receives is known as an inflow. Similarly, the cash that goes out is known as an outflow.

While operating costs typically have the largest impact on cash flow, anything can affect it. As such, it’s important to pay attention to things like your investments and financing costs. A positive cash flow occurs when more money is coming into your business than is leaving it.

When this happens it’s known as your business being in the black. However, when more money is leaving than coming in, then this is a negative cash flow. That means that your business is in the red.

Many businesses also want to try to maximize free cash flow or FCF. This refers to the amount of money made through daily operations minus any money that’s spent on capital expenditures.

Why Is Cash Flow Important?

Source: pexels.com

Now that you know more about cash flow, you’re probably wondering why you should care so much about it.

The most obvious reason why cash flow matters are that it’s responsible for keeping your business afloat.

If you want to pay your bills and keep your doors open, then you will need a positive cash flow. Otherwise, eventually, you’ll be forced to shut down. However, it’s also important if you ever want to expand.

Growing your business is expensive. It can often involve opening a new location, hiring new people, and purchasing new equipment. If you want to invest in these things, then you will need cash to cover the costs.

Cash flow also helps you make better business decisions. For example, if you notice your positive cash flow is dwindling, then it’s probably not a good idea to make an expensive new purchase.

Knowing your cash flow can help make this informed decision. Cash flow is especially important for seasonal businesses.

These types of businesses usually experience a lot of positive cash flow in the Summer or Winter months, which drops later on in the year. To deal with the slow periods it’s important to stretch your cash made from the busy seasons.

What Are the Different Types of Cash Flows?

There are three main types of cash flows that you should be familiar with. These include cash flows for operations (CFO), cash flow for investing (CFI), and cash flow for financing (CFF). Cash flow for operations describes the cash coming in from production or daily sales.

As long as your CFO is high, then you will be able to pay for operating costs like bills and rent. You can find your CFO by taking your operating costs and subtracting any operating costs that you paid for with cash.

Knowing your CFO is important if you plan on expanding because it can tell you whether or not you need capital expansion. Next, is your CFI. This refers to any cash your business may have made through investment opportunities.

Keep in mind that negative cash flow with investments isn’t always a bad thing. In some cases, it can show that you’re investing in the long-term health of the company using research and development.

Finally, there’s CFF. This refers to cash that’s used to fund your business and its capital. This includes things like paying dividends, issuing debts, and equity.

How Do You Track Cash Flow?

Source: pexels.com

Tracking your cash flow allows you to detect fluctuations quickly and adjust them as you see fit. To do this you should track two specific areas: income and expenses. You can track your income by keeping invoices of the people who have and haven’t paid you.

For example, let’s say you sell Bitcoin. It would be important to keep the invoice from this transaction. Not only does it allow you to keep track of your income, but it also makes tax season much easier.

Next, you should track expenses or all the money you’re spending. It helps if you have one debit or credit card that you put all your business expenses on. However, you can also try snapping a shot of your receipt every time you make a purchase.

Regardless of the method you choose, we recommend that you stay as organized as possible. Accounting software can make your life a lot easier in this regard. However, choose the option that works best for you.

Want More Content? Keep Exploring

Source: pexels.com

We hope this article helped you answer the question, What is cash flow? As you can see, cash flow is important because it reflects both your revenue and expenses. As such, it’s a vital indication of how well your business is doing.

Because of this, you should do everything that you can to track it closely. Did you enjoy this article? If the answer is yes, then you’re in the right place. Keep reading to find more topics that you’re sure to love.

Related posts

How to Choose the Right Accounting Method for Your Small Business

Ryan Marsh

How to Earn on Forex in 2021

Sandra Evans

4 Tips on How to Stick to a Budget Without Sacrificing What You Love

Sandra Evans

This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Accept Read More

Privacy & Cookies Policy