Cash is the lifeblood of every business and running out of it is the number one reason that small businesses fail. Even if you are making plenty of sales if you don’t have enough cash in the bank your business won’t be able to pay its bills and stay open.
That’s why it’s so important for businesses to understand the basics of cash flow and cash flow forecasting. Here’s everything we’ll cover in this guide to get you up to speed on everything regarding cash flow:
Cash Flow Definition
Cash flow measures how much money is moving into and out of your business during a specific period of time.
Businesses bring in money through sales, returns on investments, and from loans and investments—that’s cash flowing into the business.
And businesses spend money on supplies and services, as well as utilities, taxes, loan payments, and other bills—that’s cash flowing out.
Cash flow is measured by comparing how much money flows into a business during a certain period of time compared to how much money flows out of that business during that same period. Usually, cash flow is measured over the course of a month or a quarter.
How to calculate cash flow
The simplest formula for calculating cash flow is:
CASH RECEIVED – CASH SPENT = NET CASH FLOW
If your net cash flow number is positive, your business is cash flow positive and accumulating cash in the bank.
If your net cash flow number is negative, your business is cash flow negative and you are finishing the month with less cash than you started with.
What’s the difference between Cash and Profit?
Believe it or not, it’s possible for your business to be profitable but still run out of cash. That may not be intuitive at first, but it’s because cash and profits are very different things. Here’s why.
Profits can include sales that you’ve made but haven’t been paid for yet.
Cash, on the other hand, is the amount of money you actually have in your bank account. It represents the liquidity of your business and basically, if you can’t use it right now to pay your bills, it’s not cash.
For example, if you’re making a lot of sales but you invoice your customers and they pay you “net 30,” or within 30 days of receiving the invoice, you could have lots of revenue on paper but not a lot of cash in your bank account because your customers haven’t paid you yet. Those sales will only show up on your income statement.
If the money your customers owe you hasn’t made it into your bank account, it won’t appear on your cash flow statement yet. It isn’t actually available to your business at this point. It’s still in your customers’ hands, even though you’ve invoiced them for it. You keep track of the money your customers owe you in accounts receivable.
Meanwhile, you can only pay your bills with real cash in your bank account. Without that cash in hand, it’s going to be tough to fulfill orders, meet payroll, and pay your rent. That’s why keeping track of cash flow is so important. To keep your business afloat, you need to have a good sense of what comes in and what goes out of your business on a monthly basis and do everything you can to remain cash flow positive.
If you want to learn more, you can check out our more detailed explanation of the difference between cash flow and profits.
How to analyze a cash flow statement
When analyzing your historical cash flow statement you’re looking at the amount of real cash you have on hand at the beginning of the month, compared to your cash at the end of the month. You can also look at your cash flow over different time frames – quarterly, for example – but a good rule of thumb is to look at your cash flow on a regular basis to better understand any changes in the health of your business.
To see a visual example of how this works within a business, you can download this free cash flow example as a PDF or Excel sheet.
When conducting a cash flow analysis, you’ll want to be sure you understand the following key terms.
Positive cash flow
Positive cash flow is defined as ending up with more liquid money on hand at the end of a given period of time compared to what was available when that period began.
Let’s say you started with $1000 in cash at the beginning of the month. You paid $500 in bills and expenses, and your customers paid you $2,000 for your services. Good news: Your cash flow is positive, at $2,500 for the month.
If you have positive trending cash flow, it’s easier to:
Negative cash flow
Negative cash flow is when more cash is leaving the business than is coming in. When cash flow is negative, the amount of cash in your bank account is shrinking. This might not be a problem if your business has plenty of cash in the bank. But, it does mean that your business will eventually run out of money if it doesn’t become cash flow positive at some point.
Let’s say you started with $1,000 in the bank at the beginning of the month. You paid $1,500 in bills and expenses, and even though you did plenty of work and invoiced your customers for $3,000 worth of services, your customers only actually paid you $200. You’re still waiting for the rest of your payments to come in. Your cash flow is negative: -$300 for the month.
If you don’t have any reserves, your rent check might bounce. If you have a line of credit already established, you might rely on that to pay part of your bills. Maybe you forecasted your cash flow, and you knew that you were going to be short that month, so you made a plan to be able to cover your expenses.
One month of negative cash flow won’t necessarily tank your business. But when you start to see a trend, and you don’t do anything to reverse it (or when you’re unpleasantly surprised because you haven’t been tracking your cash flow), that’s when your business is at risk.
Cash Burn Rate and Runway
New businesses and startups often have negative cash flow when they’re first getting started. They have lots of bills to pay while they’re getting up and running and there aren’t a lot of sales yet. As revenue from sales starts to come in, hopefully, cash starts to flow into the business instead of just flowing out. This is why new businesses often need investment and loans to get started—they need cash in the bank to cover all of the negative cash flow that happens during the early days of the business.
When first starting out, it’s important to track Cash Burn Rate, which is essentially your negative cash flow number – the amount of money you are “burning” each month. You can then use that number to figure out how many months of cash you have left – this is your “runway.” Read our detailed explanation of cash burn rate and cash runway to learn more about how to find, measure, and adjust these metrics.
Negative cash flow can also happen when a business chooses to invest in a new opportunity. The business could be betting that investing in a new opportunity now will pay off in the future. That investment could cause negative cash flow for some time, so it’s important to keep a close eye on cash and have a solid cash flow forecast in place so you know if your business is on track to stay in the black.
Why cash flow forecasting is important
You’ll want to monitor your historical cash flow at least once a month so you can start spotting trends with what’s actually happening with your cash inflow and outflow.
But it’s not just measuring the past and present, forecasting your cash flow can also help you anticipate when your business might run low on cash in the future. You can then plan ahead and open a line of credit or find other loans and investments to help you cover that point in the future when you’re going to need a little extra cash.
It’s a lot easier to get help from a bank or investor before you’re actually in a crisis where you’re not sure you can cover your bills. If you wait until you’re really in trouble to take action, lenders may see you as too much of a risk and turn down your request.
Your cash flow forecast can also help you plan the best time to make a big purchase, like a new piece of equipment or a company vehicle.
Don’t forget to account for the unknown, though. Business owners can’t predict the future—particularly when it comes to any unforeseen expenses they might incur (e.g., a truck breaking down prematurely and needing replacement, or a data breach resulting in a forced increase in IT spend). And they also can’t know for certain that their clients will pay their bills on time.
So, when you’re forecasting or looking at your cash flow statement for last month, remember that having some buffer is a good thing. You don’t want to be in a position where you’ve allocated every single penny, to the point where you can’t accommodate unexpected expenses.
Part of reviewing your cash flow should be thinking about risk, and the effect an unexpected expense will have on your available cash—and ultimately, your ability to pay your bills.
How to forecast your cash flow and build a cash flow statement
A cash flow projection is all about predicting your money needs in advance.
Unfortunately, though, forecasting your cash flow is a bit more complicated than forecasting other aspects of your business such as your sales and expenses. Your cash flow statement takes inputs from your revenue projections, your expense projections, and also your inventory purchase plans if your business keeps inventory on hand.
In addition to that, you need to predict when your customers will pay you – will all of them pay on time? Or will some take longer to pay?
A tool like LivePlan can greatly simplify cash flow forecasting, but you can also do it yourself with spreadsheets if you want.
There are two methods you can use to build a cash flow statement: theand the . While they will both arrive at the same end-result and predict how much cash you will have in the bank in the future, they accomplish that goal in different ways.
The direct method of forecasting cash flow
The direct method provides a very clear view of how cash moves in and out of a business. You essentially add up all the cash that your business has received from various sources and then subtract all the cash that is paid out to suppliers, vendors, employees, etc. This number will be the amount of cash you’ve either added or subtracted from your bank account during the month.
The indirect method of forecasting cash flow
The indirect method starts with your net income from your Profit and Loss Statement and then makes adjustments to that number to account for non-cash expenses such as depreciation. From there you make adjustments to account for changes in inventory, accounts receivable, and accounts payable.
The indirect method is very common for building historical cash flow statements because the numbers that are required are all easily generated from your accounting system. This makes it a fairly popular method for forecasting cash flow, although the direct method is generally easier for people who aren’t as familiar with the intricacies of accounting.
Read our guide for a more detailed explanation of the two methods of creating a cash flow statement.
Forecasting cash flow
If you’re forecasting cash flow using spreadsheets, I recommend using the direct method. It’s easier and more straightforward.
Essentially, you want to create future estimates of when you’ll receive money from customers and when you’ll pay your bills.
It’s not critical to forecast every individual invoice and bill payment, though. Forecasting is about helping you make strategic decisions about your business, so making broader estimates in your forecast is OK.
Read our guide on forecasting cash flow to get a detailed explanation of how to create both a direct forecast and an indirect forecast.
How to improve your cash flow
If your cash flow is negative or you’re just looking for ways to improve your cash flow in general, there are plenty of options available to you. Here’s a quick list of things you can do:
Depending on your situation, you may use these methods or even consider more drastic measures if the broader economy is impacting your ability to create positive cash flow.
For more detailed advice and information, read our expert troubleshooting tips to improve your cash flow and our guide for managing cash flow in a crisis.
Additional reading to help you better master cash flow
Cash flow is a big topic and there are many other resources that you may find helpful. Here’s our top list of what you should consider reading next:
How to balance cash flow in a seasonal business
Seasonal businesses have unique challenges you’ll want to consider, including variations on cash flow management. Check out these techniques to effectively balance your cash flow and avoid any seasonal surprises. Read more.
Using invoice factoring to safeguard your cash flow
If you have clients or customers who take forever to pay, this can cause cash flow problems for your business. Fortunately, solutions like invoice and spot factoring can act as a safeguard, to help protect your cash flow against future disasters. Read more.
Tips for better cash flow for your business
Solid cash flow management is crucial to business success. If you’re having trouble managing your cash flow, these strategies will help you improve. Read more.
How to get help with a business line of credit
Every business experiences cash flow challenges. Instead of avoiding them, measures like a preemptive line of credit can help keep you running smoothly. Read more.