Cash Flow Word With Coin In Glass Jar and graph up. Financial Concept

Cash Flow 101

Posted May 27th, 2021

We’ve created a lot of resources about the importance of cash flow management for your business. Let’s take a step backward and start at the beginning. What IS cash flow and why is it so important to understand your company’s cash flow?

What is Cash Flow?

Cash flow is the net amount of cash (and other cash-equivalent assets) that move in and out of your business. They flow in when cash is received — which is called inflows — and they flow out when money is spent (outflows).

Cash flow is often referred to as “the lifeblood of your business,” but another analogy is that cash flow is your company’s oxygen. Cash must flow in, and cash must flow out. This flow of cash in and out of your company is needed to keep it breathing — to pay your team and your vendors, to invest in growth and to heal from unexpected challenges or adversity.

There are several types of cash flow business owners should know, understand, and track. Let’s quickly define these, along with a few other terms you should understand in order to manage the finances of your business.

Operating cash flow is all cash generated by the purchase of your company’s main service or product.

Investing cash flow includes cash generated by investments in capital assets or other ventures.

Financing cash flow is the money you take in from debt or equity, less the payments you make on that debt or equity.

Positive cash flow shows that your cash flow is increasing — more money is coming in than out.

Negative cash flow, conversely, shows that your company has more outgoing money than incoming.

IMPORTANT NOTE: Cash flow can shift from positive to negative or vice versa from week to week or month to month. This is why proper cash flow management is so important.

Free cash flow is the money leftover after all expenses are paid. Free cash is one of the most important aspects of cash flow management, as it determines your ability to grow, to recover from a bad project or a bad season. Free cash flow can also impact your team’s performance.

Operating account is the general bank account used to process most of a company’s expenses. Many businesses run everything through an operational account, however, we recommend setting up at least one separate account.

Payroll account is a bank account reserved for payroll activity. Separating this from operations ensures you always have enough money for payroll, and that you can easily track payroll separate from other expenses, ensure the payroll taxes are paid, and any other employee related compensation associated to the business.

How cash flow relates to profit

Obviously not all of the money generated by your company’s activities is profit, but it is all part of your cash flow. Knowing how much of the revenue generated is profit, or free cash, and how much must be reserved for expenses, is critical to cash flow management and the vitality of your business.

It is entirely possible to be profitable and have a negative cash flow. This is especially common if there is a long delay in payment and whether or not you are running using Accrual or Cash based accounting. It is also possible to have a positive cash flow and not be profitable. For example, if a construction contractor company is taking on some additional debt or factoring their receivables they could likely create positive cash flow for a certain period of time. However, if the company’s bids are too low to accommodate overhead and project expenses, or the company’s debt payments or overall expenses are too high, the company will not be profitable despite the additional cash created by the loan or factoring.

Managing your company’s cash flow

The first piece of advice we give clients struggling with cash flow management is, Hire an accountant. Preferably a CPA. This first step is a huge differentiator.  The accountant will create a structure to manage your books and your business

A lot of business owners start out managing their own books, only to discover too late that business financial management is far more complex than balancing your household checkbook. Hiring an experienced accountant or CPA pays for itself when you consider:

  • the time you’ll save NOT keeping accounts in order, cutting checks, and worrying about the business bank account
  • the late fees and overdraft fees you WON’T incur when someone is properly managing company finances
  • the potential revenue-generation strategies your accountant will uncover by analyzing your company financials
  • the stress relief AND potential savings when taxes are in order and returns filed properly
  • the growth you’ll experience when you have a financial game plan that supports your goals

PRO TIP:  We see companies that hire and work with an accountant all year save thousands of dollars — more than what the accountants fees are — just in tax savings alone. Many business owners think accountants are too expensive and hire them at the end of the year just to do the taxes. At that point they are very likely not getting any real value, compared to if that accountant was in place all year long and set up the financial system from the beginning.

Whether you hire a professional to manage your accounting or continue to manage it yourself, you need to educate yourself on your company’s financials. What is your monthly overhead? What terms do you have with suppliers? What profit margin are you currently averaging on new work? Even if a CPA is pulling these numbers for you, it is important for you to understand them in order to know what actions you need to take in order to keep your business profitable and growing. This is also the real hidden value in having a CPA / Accountant on your team.

The last tip is to track your cash flow. Expenses can shift and new work or growth can mean new costs as well as new revenue. Tracking cash on a regular basis (weekly, monthly, quarterly, depending on your business’s needs) and estimating the expected flow on projects lets you see problems in advance and solve for them.

Want more cash flow tips? Read this blog next:

Cash Flow Management Tips for Small Businesses

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