What Is Cash Flow?

Definition

Cash flow is the money that is moving in and out of your business each month.

Cash Flow — How It Works to Keep Your Business Afloat
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The Balance

Key Takeaways

  • Cash flow is the way money moves in and out of a business from month to month.
  • Customer purchases and payments are cash going in, and business expenses are cash going out.
  • Managing cash flow is important especially for new businesses and seasonal business.
  • You can run a cash flow report to monitor the flow of cash into and out of your business.

How Cash Flow Works

Cash flow is the money that is moving (flowing) in and out of your business in a given period (such as a month).

  • Cash in: Cash comes in from customers or clients who buy your products or services. If customers don't pay at the time of purchase, some of your cash flow is coming from collections of accounts receivable.
  • Cash out: Cash goes out of your business in the form of payments for expenses, such as money to vendors, rent for office space, monthly loan payments, taxes, and other accounts payable.

The best way to keep track of cash flow in your business is to run a cash flow report. This report shows the cash you received and the cash paid out to show your business's cash position at the end of every month. At times, you may need to keep track of cash flow on a weekly, or even daily, basis. 

A quick and easy way to perform a cash flow analysis is to compare your total unpaid purchases to the total sales due at the end of each month. If the total unpaid purchases are greater than the total sales due, you'll need to spend more cash than you receive in the next month, indicating a potential cash-flow problem.

Note

Your accounting software should have a cash flow statement as one of the standard reports, or your accountant can run it for you.

Example of Cash Flow

Cash flow is what happens to cash when a customer pays a bill, when your business buys supplies, or when you pay an employee or an independent contractor. Cash moves into your business when you receive a payment, and then out again when you pay expenses.

Cash vs. Real Cash

For some businesses, such as restaurants and some retailers, cash is really cash: currency and paper money. The business takes cash from customers and sometimes pays its bills in cash, too. Cash businesses have a special issue with keeping track of cash flow, especially since they may not track income unless there are invoices or other paperwork.

Think of cash flow as a picture of your business checking account over time. If more money is coming in than is going out, you are in a "positive cash flow" situation and you have enough to pay your bills. If more cash is going out than is coming in, you are in danger of being overdrawn, and you will need to find money to cover your overdrafts.

Note

Cash businesses are more at risk of being ​audited by the Internal Revenue Service (IRS) because it's easy to hide cash income and not report it.

Importance of Cash Flow

Lack of cash is one of the biggest reasons small businesses fail. It's also called "running out of money," and it will shut you down faster than anything else.

When Starting a Business

Dealing with cash flow issues is most difficult when you are starting a new business. You have many expenses, and money is going out fast. And you may have few or no sales or customers who are paying you. You will need some other sources of cash, such as a temporary line of credit, to get you going and create a positive cash flow.

The first six months of a business are a crucial time period for cash flow. If you don't have enough cash to carry you through this time, your chances for success aren't good. Suppliers often won't give credit to new businesses, and your customers may want to pay on credit, giving you a "cash crunch" to deal with.

Note

In estimating your cash flow needs for your startup, include your personal living expenses that will need to come out of the business. The less you need to take from your business for personal costs, the more you can devote to your business during the crucial startup time.

Seasonal Business

Cash flow is also particularly important for seasonal businesses—those that have a large fluctuation of business at different times of the year, such as holiday businesses and summer businesses. Managing cash flow in this type of business is tricky, but it can be done with diligence.

Cash vs. Profit

It's possible for your business to make a profit but have no cash. How can that happen? The short answer is that profit is an accounting concept, while cash, as noted above, is the amount in the business checking account. Profit doesn't pay the bills. You can have assets, such as accounts receivable (money owed to you by customers), but if you can't collect what's owed, you won't have cash.

Requirements for Managing Cash Flow

There are steps you can take to better manage your cash flow and avoid a cash flow emergency.

Control Inventory

Having too much inventory ties up cash. Keep track of inventory so you can estimate your needs better. You may find it necessary to discount prices in the short term in order to move a lot of inventory, generate cash, and get back to a better level.

Collect Receivables

Set up a collections schedule, using an accounts receivable aging report as a guide. Follow up on non-payers so those payments don't fall through the cracks. Keeping up with accounts receivable will prevent a cash crunch.

End Unprofitable Relationships

Decide when it's time to end a relationship with someone who never pays. You can then use that time to focus on clients and customers who contribute to bottom line, not detract from it.

Note

If you have time to do only one business analysis every month, make it a cash flow statement to keep track of your cash position.

How To Get Cash Flow Help

Many businesses get help with temporary cash flow shortages by setting up a working capital line of credit. A business credit line for working capital works in a different way from a loan.

When you get a credit line, you have a certain amount of credit in an account that you can draw on when you are short of cash and pay back when you have extra cash. You owe interest charges only on the amount taken out. For example, if you have a $25,000 line of credit, and you have taken out $10,000, you would pay interest only on the $10,000. If you were to take out a loan instead, you'd have to repay the entire amount (with interest), even if you didn't need all of it.

Frequently Asked Questions (FAQs)

What is a cash flow statement?

A cash flow statement is a financial report that details the cash coming in and going out of a business. It contains three main parts: cash from operations (such as sales), cash from investing, and cash from financing (such as loans or lines of credit).

What is an example of cash flow?

Suppose you have a company that produces coffee mugs. Customer purchases of mugs would provide cash coming in to the business, while payroll would represent cash going out. Cash might also flow in as the result of any investments owned by the company, or cash might flow outward in the form of loan payments, taxes, or overhead costs. A cash flow statement would document the movement of these different types of cash.

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Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
  1. Harvard Business School. "Cash Flow vs. Profit: What's The Difference?"

  2. Small Business Administration. "Why a Business Line of Credit May Be a Smart Choice for Your Business."

  3. Consumer Financial Protection Bureau. "What Is a Personal Line of Credit?"

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