What is Cash Flow?
Cash flow involves the amount of money that is gained and spent by a business. Cash flow work in two ways.
- Cash that comes into a business through customers buying products from a business or clients hiring a service from a business.
- Cash that goes out of a business in the form of expenses for a company for paying loan installments, wage bills, or other business-related expenses.
With a two-way flow of money, businesses can be termed as having a “positive cash flow” if the money coming into a business is more than the money that goes out in the form of spending. When the amount of money, that goes out of a business is more than the money that comes into the business it is known as “negative cash flow” which causes overdraft that companies need to find a way to cover. It is important that business have good “working capital” to cover the issues with cash flow.
Importance of Cash Flow in Business
The importance of cash flow for a business cannot be understated. A large number of businesses that include startups and large-scale companies fail due to “insufficient cash reserves” it’s impossible for any business to survive without “adequate funds” to keep the business running.
Cash Flow in the Initial Stages of a Business
Cash flow when starting a business is very important in determining the success of a business. It is very important to maintain a “positive cash flow” when starting a business as the expenses will be more in spending for the setup of the company. There will be very limited cash that comes into a business from customers since the business is in its initial stages.
Comparison of Cash Flow with Profit
The amount of cash on hand does not really indicate profit or loss. There could be profit even without real cash. Wondering how? It is not as complicated as it sounds because the cash that shows in accounting statements is not inclusive of the amount of cash owed by the customers or clients to the business. Significantly higher account receivables that have not been collected yet is profit that does not really show as cash available.
Significance of Cash Flow Statement
The most effective way of keeping track of cash flow for business is to maintain a report on cash flow.
A cash flow statement is crucial in tracking the cash in business checking account with the variations in cash in other accounts through a business balance sheet. There needs to be cash flow report on weekly or even daily basis to keep track of cash flow at all times, since cash flow is the life line of a business.
Cash flow statements can help you track the following.
- Total sales in a month
- Purchases made for the business and the amount yet to be paid for the purchases
- The difference in the sales and the amount to be paid as expenses is the income that is required to be maintained in a healthy manner to keep the business operations running smoothly.
Cash Flow Uses
Cash flow can be useful for the following.
- NPV or net present value can help calculate value of money present currently with the value of money over a period.
- Internal rate of return which can be used to calculate the profitability of an investment.
- Availability of liquid assets for a company
- Measuring the cash generated by operations currently running in a company.
- A funding gap also known as a shortfall of money for running business operations smoothly.
- Money paid to shareholders on company profits.
- Money spent by a company on acquiring fixed assets.
- The amount of time between spending on inventory for business and receiving payments.
The importance of cash flow is the single most important metric in running a business. It helps in operating a business smoothly and make crucial financial analysis that determines the success of a business.