Cash Flow definition

Though many people often focus on how profitable a business is, many experts argue that cash flow is a better indicator of how healthy a company or franchise unit is. Here, we take an in-depth look at what cash flow is, how it is calculated, and how you can improve it.

>> Read More: What is liquidity?

Cash flow definition business

Cash flow is defined as the movement of cash and other liquid assets into, through, and out of a business. If a company has more money coming in than going out, it has a positive cash flow. If there’s more cash leaving the organisation than coming in, it has a negative cash flow.

Cash circulating through a business is subject to certain natural ebbs and flows – sometimes there will be more money coming in and sometimes less. A company can be highly profitable, go through long periods of running a positive cash flow, and still occasionally struggle with stretches during which they have a negative cash flow. For this reason, businesses need to maintain access to a healthy supply of working capital. Otherwise, the cash flow shortages may result in the business being temporarily unable to cover its debts.

The long-term goal of any business is to turn a healthy profit. This is achieved by generating positive cash flows over a long period. In this sense, understanding cash flow is key to successful business management.

What is a cash flow statement?

The Cash Flow Statement (CFS) is one of the principal means by which we measure, record, and analyse the cash (and cash equivalents) that enter and exit a business. It gives business owners and managers insight into where money is coming from, where it is going, and how smoothly it is moving through the organisation. How the business receives, processes, and pays out cash is known as its cash position and is an important factor in determining whether other companies are comfortable working with an enterprise.

Where cash flow is on a statement

Every CFS is typically structured in the same way, though there can be slight discrepancies between businesses and industries. In the vast majority of cases, it is broken down into three main categories. These are:

  1. Cash from operating activities (e.g. sales, purchases, and other similar expenditures)
  2. Cash from investing activities (e.g. the buying and selling of non-immediate or long-term assets such as equipment)
  3. Cash from financing activities (e.g. activities concerning borrowing and lending)

A business’ accountancy team completes each of these categories, and the business’ total change in cash and cash equivalents is recorded at the bottom of the CFS.

Net cash flow definition

Net cash flow is a term that refers to the difference between a business’ income and outgoings over a certain period. This means that it is essentially the figure submitted under the Change in Cash and Cash Equivalents at the bottom of the CFS. Net cash flow is one of the most important figures for any business, as it is likely to determine the extent to which a company can grow and develop. A higher net cash flow ensures the business will be able to develop new products and services, repay outstanding debts, and pay out dividends.

Cash flow forecast definition

A cash flow forecast is an informed estimate of how much a business expects to receive and pay out over a specified period. This is calculated by studying the various revenue streams, operating costs, and other expenditures that the business generally makes. However, cash flow forecasts differ from profit forecasts due to the way in which they deal with more than just quantities (of income and outgoings) – they also detail when these payments are likely to occur. This ensures that a business does not run into unexpected cash flow problems and that it always has sufficient liquid assets to meet its obligations to creditors. They are an essential component of any business plan.

How cash flow affects businesses

Cash flow affects businesses by determining whether, at any one moment, they have the liquid assets required to meet their obligations and continue trading. If a company demonstrates poor cash flow management, it may end up failing to pay partners, creditors, and staff. This can prove terminal for a business. However, limited cash flow can also impact on a business' ability to finance growth and expand its operations. If too much of an enterprise's assets are tied up in stock or outstanding invoices, it will be unable to find the capital required to finance expansion. A business can be highly profitable, but if its cash flow is not large enough and it cannot make the investments needed to take it on to the next stage, growth will be hampered.

How cash flow can be improved

There are numerous ways in which a business can improve its cash position and cash flow. Below, we take a brief look at five ways in which this can be achieved.

  1. Make payments speedier – the quicker payments can be made and received, the easier cash flow is to manage. This means that cash flow can be improved by setting payment terms (e.g. invoices must be paid within 30 days) and ensuring the right payment technology is in place.
  2. Apply for a business credit card – for smaller, growing enterprises, a business credit card provides access to a line of credit that can act as a safety net should cash flow become tight.
  3. Take advice from the experts – as a business owner and manager, there’s no way that you can be an expert in every area of business and financial management. This means that you’re going to have to request help from industry experts (e.g. a financial advisor or bank).
  4. Build a good credit rating – a healthy business credit rating will ensure you get the best deals on certain investments and will also help you secure finance should you need it at short notice.
  5. Offer discounts for quick payment – if you want to help improve your cash flow, it may be a good idea to offer discounts on prompt payment. This means that when a business pays you within a certain amount of time, they have to pay less. 
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