What is Cash Flow and Why Is It So Important?
Many financiers and business owners will agree that there is one four-letter word that is more important to a company than any other. C-A-S-H. Cash within a business is much like the waves of the ocean. It is constantly coming in and going back out. It comes in and goes out. That process repeats itself an infinite number of times as long as the company is doing business. So, how do you measure something that is constantly changing, and why do you need to track it anyway? The answer is cash flow. Allow us to explain why this important financial report can set your business up for greater success and longevity.
What is Cash Flow?
Cash flow is the financial measurement of the amount of cash generated by a business against the amount of cash spent by the business in the same time period. Cash generated includes sales or service revenues and interest earned, while expenses include loan payments, payroll, and other business costs. A timely statement of cash flow is just as important to the success of your business as the P&L Statement and the Balance Sheet, and often helps you make important decisions for your business.
Why Is Cash Flow SO Critical for a New Business?
It is particularly critical to have insight into your company’s cash flow for a new business that is just getting started. When a business first opens its doors, it typically has a significant amount of expenses that are necessary to get the business off the ground, but it does not have sufficient sales and receivables coming in to support the cash that is going out. When this is the case, it can be critical for a new business to obtain third-party financing to generate working capital that can safeguard and support the business in the beginning stages. Without supportive financing, many new businesses fall into a state of “negative cash flow” where their expenses exceed the cash coming in. This is one of the most common reasons why a new business fails in its early stages.
Does Profitability = Positive Cash Flow?
Interestingly enough, it is possible for a business to be profitable while still having negative cash flow. You may be thinking, “How? That makes no sense.” An example of this would be a company that has a large portion of its revenue tied up in accounts receivables that need to be collected. So, the sales that are reported on an income statement doesn’t always reflect the whole picture of a company’s cash activity.
How Can I Use Cash Flow To Manage and Grow My Business?
A cash flow report can help you make critical management decisions for your business before it runs aground from lack of cash. It will also help you determine where to focus your business efforts to increase cash. For example, it could help you identify whether you need to collect on a large balance of outstanding customer accounts receivables. It could also illustrate a need to research and seek third-party capital investments to bolster cash receipts and support your expenses. If you find that your company is efficiently managing expenses and consistently maintains a large, positive cash flow, then it will alert you that this would be a great time to invest in your growth and expand your business into new avenues. A healthy positive cash flow also puts businesses in a better position to negotiate more attractive financing terms with lenders and larger discounts with suppliers.
What Tools Can I Use to Track Cash Flow in My Business?
In order to track cash flow within your business, the statement of cash flows is the gold standard. Standard accounting software such as Quickbooks will have a cash flow statement available as one of the standard financial report options, and your accounting team should be well-versed in running this report often.
The statement of cash flows breaks down cash flow in the business into three general categories:
- Day-to-day operating activities such as cash and credit card receipts and collecting on customer accounts receivables.
- Investing activities that involve fixed assets coming into and out of the business
- Financing activities like investment capital and business loan cash infusion
How is Cash Flow Used by Outside Investors to the Company?
Here are a few ways the statement of cash flows is used:
- The cash from operating activities is compared to the company’s net income. If the cash from operating activities is consistently greater than the net income, the company’s net income or earnings are said to be of “high quality” by investors. If the cash from operating activities is less than net income, a red flag is raised as to why the reported net income is not turning into cash.
- The cash flow statement identifies the cash that is flowing in and out of the company. If a company is consistently generating more cash than it is using, the company will be able to increase its dividend, buy back some of its stock, reduce debt, or acquire another company. All of these are perceived to be good for stockholder value.
- Some financial models are based upon cash flow.
How Can Preferred CFO Help You With Cash Flow?
No matter your business goals, Preferred CFO can help you utilize the statement of cash flows to achieve your desired business results. We can help you identify areas where cost reductions can be taken to reduce expenses and create positive cash flow. We can help a new business with startup costs to identify the amount of negative cash flow in order to obtain the necessary financing to stay in business. We can also help you set up a forecast for recurring revenue and expenses so that you can plan for your business’ future.
We are ready and excited to help you increase profitability and grow your business to the level that you are hoping to achieve. Let’s chat about how we can help you meet your financial goals. Call today to schedule your free consultation.
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