Understanding Cash Flow

Cash flow is the lifeblood of any business. Like it or not, cash is how business keeps score. If you don't have enough cash on hand, you can't pay your suppliers, your employees, or your financers. Without sufficient cash, you'll go out of business soon enough.

Cash flow is the flow of spendable money into your business and back out again. You may have sold tons of goods and have a fistful of invoices to show for it, but you can't spend those invoices, paying employees and suppliers with them. You need the cash.

Cash Flow Tools

Managing your cash flow can be a tricky business, and your business policies regarding how you extend credit to your customers, how many customers you have, and how quickly they pay, for example, all can combine to make it too complex to track in your head. When it gets this complicated, smart business managers turn to computerized tools to help them get a handle on the process, the risks, and the opportunities.

Profit and Loss

Cash flow isn't the same as profit and loss. Believe it or not, a company can be profitable while experiencing cash flow problems that drive it to bankruptcy. Profit is an accounting term, which includes noncash items and estimates. Cash flow is a less forgiving number with a harder edge that factors in payments and expenditures. If your sales are profitable but you need to invest millions in a new plant and equipment to make the products you sell, cash flow may not be a pretty sight.

Cash flow can be more difficult to predict than profit and loss, particularly for smaller businesses that are dependant on a few large customers. You may be able to estimate when you will close a sale and earn the profit. But you may have little control over when your customers pay you and the cash comes in.

Payments and Receipts

Cash is not the balance in your business bank account. Your cash balance in your accounting books needs to cover checks you have issued that have not yet been paid by your bank. You may have customer payments in hand that have not yet been deposited in your bank. That's cash, too.

Where does cash come from? For most businesses, a major source of cash comes from sales to customers. It's not necessarily a direct path, though. Many businesses extend credit to customers, so the sale hangs around as an account receivable, preferably for as short a time as possible, before the customer sends payment for the purchase and the receivable converts to cash. Cash can also come from financing activities, such as a bank loan or an investment by the business owners.

Where does cash go? Just about where you would expect: to pay suppliers and employees and investments in the business. It may also be used to repay debt or provide an investment return to owners.

Cash flow can be more difficult to predict than profit and loss, particularly for smaller businesses that are dependant on a few large customers. You may be able to estimate when you will close a sale and earn the profit. But you may have little control over when your customers pay you and the cash comes in.

Typically, a business has more control over its cash payments than its cash receipts. Granted, your employees expect to receive their pay on payday. However, you may be able to stretch the time you take to pay your trade suppliers, within reason, of course.