What Is Cash Flow And How Does It Work?
Do you often feel overwhelmed when it comes to sorting your expenses at the end of the month? Many business owners feel the struggle of a thinning revenue stream. If that’s the case with you then start reassessing the situation with your finances right away. Understanding the meaning of cash flows and how to sustain them positively can help pull you out of this rut.
What Is Cash Flow?
Before anything, it’s important that you know the cash flow definition. Bear in mind that this is quite different from profit. The latter refers to the difference between the investment made and revenue earned. A cash flow, on the other hand, doesn’t have anything to do with this difference. It’s more than possible for businesses to have strong revenue streams without the ability to make a good profit.
So what is cash flow?
It’s simply the money that flows in and out of a business. Ideally, there should be more money flowing into your business and less of it flowing out. A negative flow of cash suggests that your business is weighed down by liabilities you didn’t account for.
Why It’s Important
There are several reasons why you just should never ignore cash flows in accounting.
- It keeps your business floating: You’ll need a positive revenue stream (i.e., more money flowing in than out) to keep the day-to-day operations of your business running smoothly. Many factors such as delayed payments, insufficient work, and unprecedented expenses can negatively impact your business cash flows. When this happens, your business risks a shut-down
- Powers scalability: If you’re a start-up or a small business, it’s more than likely that the next agenda on your ‘to do’ list is scaling. However, scalability comes with greater equipment purchases, marketing, miscellaneous expenses, and overhead costs. You can only meet these requisites with positive and regular cash flow
- Enables smart business decisions: Keeping tabs on your monthly and annual cash flows can help you make smarter business decisions in the long run
Cash Flow Calculation
Your available resources can be calculated directly or indirectly.
Indirect Method
An indirect revenue stream statement is more common among business owners. Here’s how it works:
- Calculating the flow of cash from operations. Imagine you have a net monthly income of $10,000. If your accounts payables increase by $1,000 and receivables increase by $2,000 then add and subtract this money from your net income respectively. The remaining figure would be $9,000. This is your net cash. To make calculations easy, use a cloud accounting software to track the payables
- Calculating the flow of cash from investment. For an investment expense of $1,000 and a sale of $500, your net cash will be determined by subtracting the latter from the former. In this case, it’s $500
- Calculating the flow of cash from finances. If you score $900 from a line of credit and spend $200 in expenses, your net cash is $700. Your total will be the sum of the net cash calculated from operations, investment, and financing
Direct Method
Calculating the flow directly will require a different method for sorting the net cash from operations. Instead of adjusting the accounts receivables and payables, the direct method subtracts the monthly expenses from the net income. Thus, for a net income of $10,000 and monthly expenses of $6,000, your net cash is $4,000.
Managing And Tracking Your Cash Flow
When it comes to managing revenue streams, the starting point is to track your income and expenses.
- Keep tabs on your invoices: You must keep track of paid and unpaid invoices. Accounting for your business is a crucial step in managing assets. Try using invoicing software for better tracking and management. Software will categorize unpaid and paid invoices. Additionally, it’ll send out timely reminders
- Track and organize your business expenses: Keep a firm grasp on your expenses and turn them into tax-friendly habits. Keep a close eye on the fixed cash flow and devise ways to reduce overhead costs
- Upgrade expense tracking with a billing software: Replacing traditional ways of tracking expenses with accounting software, such as QuickBooks, can do wonders for your business
Tips To Improve Cash Flow
Here are a few ways to help improve your assets.
- Upgrade recordkeeping: Messy bookkeeping can make calculations ten times as difficult. You can skew the invoicing impact on cash flow positively with a billing software and timely recordkeeping
- Issue invoices on time: Delayed invoice payments are often the reason behind a negative business cash flow. Remember to issue the invoices on time. You may add a reward or punitive policy for early and late playing clients respectively
- Finance your invoices: If you’re in dire need of cash, try financing or factoring. This is the practice of borrowing a loan against the outstanding invoice after submitting it as security
- Cutback on unnecessary expenses: Wherever possible, start with cutting down on reducible costs. As much as you think your costs are unavoidable, there’s always room to spare some cash
Conclusion
Understanding cash flow is easier than you think, provided that you keep your guards up at all times. Many businesses suffer in the final moments of tax season. Avoid these unnecessary struggles by sustaining a positive revenue stream.
