Everyone’s heard the refrain “cash is king” when it comes to running a small business and it certainly can be true. There are many new or small companies that are profitable but are still forced to close their doors because they didn’t manage their cash flow appropriately. That’s why careful cashflow analysis is incredibly important when you’re running a business.
Cash flow analysis is basically keeping track of when and how cash flows into or out of your business. This is different than just tracking your revenues and expenses because revenues and expenses should be tracked based on when money is earned or spent, not when it’s actually received or paid out. Depending on your business, your clients may not pay you for up to a couple of months after you’ve already delivered a service or product, so you have technically earned the revenue, but you don’t have that cash in the bank to pay your bills.
There are 3 types of cash flow in any business: cash flow from operating activities, cash flow from financing activities, and cash flow from investing activities.
Cash flow from operating activities is that related to the core business and you’ll be able to use the income statement to figure out the cashflow from operating activities by taking the net income and adding back in expenses like depreciation that are not actual cash outflows and adjusting for accounts receivable and payable – cash that has been earned or spent but hasn’t actually been received or paid.
Cash flow from financing activities is that which is related to – surprise – financing activities – things like loan payments you make or payments you receive from loans made to others.
Cash flow from investing activities is that associated with any investments the company has made like the purchase or sale of land or equipment.
A statement of cash flows is one of the three basic financial statements but somehow still gets overlooked by many entrepreneurs. If you’re not familiar with it, you should speak with your financial officer or accountant to get an understanding of what your business’ cash flow looks like. You can also buy my business planning book and review the section on creating financial projections to develop your understanding of the importance of cash flow and how to determine and analyze it. You can get the Kindle version here and other ebook formats here.
Basically, cash flow will give you an idea of the financial health and liquidity of your business by showing you what you actually have available to use to meet the company’s obligations. $1 million dollars in profits isn’t as awesome as it sounds if your cash flow is such that you can’t pay your rent and will be evicted before you can ever collect that $1 million. You need to make a point of regularly reviewing your cash flow and making any adjustments where necessary to improve the health of your business. If you spot some problems, try taking a look at my old video for some tips on how to improve small business cash flow.