Business cash flow: an explainer

Cash flow is the measurement of cash coming into a business and going out of it at a particular time. It considers the net cash balance – the cash that remains after all liabilities are subtracted from it – and is a good indicator of the financial health of a business, ensuring the enterprise can pay its operating expenses and invest in new growth.

There are two types of cash flow:

• Positive cash flow. This term applies when businesses have more cash coming into the organisation – known as cash inflow – than going out of it.  Cash inflows are typically revenue generated by the sale of products or services and from investments, interest, royalties, and so on.
• Negative cash flow. This term applies when businesses have more cash going out of the organisation – known as cash outflow – than coming into it. Cash outflows typically include employee salaries, taxes, repayments, supplier invoices for inventory, and other operational costs, such as equipment and building space.

What are the benefits of a positive cash flow?

Having positive cash flow brings a number of benefits to a business. In fact, it’s often referred to as the lifeblood of business because it largely determines the amount of working capital the business has available to fund its day-to-day operating activities – and ultimately determines the success of the business more widely. This is because a positive cash flow demonstrates that an organisation has the liquid assets it needs to cover the cost of doing business – a concept known as liquidity.

Positive cash flow can also act as insurance against periods of change or economic uncertainty. This can include short-term challenges – for example, small business owners should have enough cash to cover them in the event of late payments from their clients – but ideally would also cover more significant challenges, including:

• Economic instability, such as during a recession or a major event like the COVID-19 pandemic.
• Market changes, such as the emergence of new competitors or consumer trends.
• Operational changes, which might include increased costs for labour, inventory and raw materials, equipment, or office and warehouse space.

A positive cash flow also enables businesses to:

• Invest in organisational growth. This might include expanding into new markets and developing new products and services or expanding business needs, such as hiring additional staff or upgrading equipment.
• Create new opportunities and access better options. By having healthy, positive cash flows, businesses are in stronger positions when negotiating with lenders and other finance providers during financing activities, and can secure more advantageous deals, discounts, and payment terms with suppliers while also taking advantage of profitable investments.
• Focus on cash flow forecasting. A cash flow forecast maps out an organisation’s projected cash flow in the weeks or months ahead. It can be created using financial or accounting software and templates, or manually in software like Excel by listing all incoming and outgoing cash within a specified period of time. Regardless of how the forecast is created, it can help businesses to better plan their future finances based on predicted positive or negative cash flow. Cash flow projections also help ensure that businesses are prepared for any periods of cash shortfalls.

What are the consequences of a negative cash flow?

Businesses that regularly operate with a negative cash flow or frequently have cash flow issues, are likely to face several challenges. For example, without enough liquid cash, businesses will struggle to pay their basic operational expenses, such as people’s salaries – and these consequences become even more challenging during periods of economic turmoil.

Negative cash flow limits how flexible and adaptable a business can be during times of change, and it can also have a detrimental impact on an organisation’s credit rating. 

Businesses faced with routine cash flow problems should aim to:

• Create a cash flow forecast and use its projected figures to plan ahead.
• Reduce spending wherever possible.
• Seek new sources of funding.

How cash flow is calculated

Free cash flow – the term for a business’s immediately available cash– is calculated by subtracting capital expenditures from the operating cash flow. 

What is the difference between cash flow and a cash flow statement?

Cash flow statements are financial statements that indicate the cash position of a business. They illustrate the amount of money coming into a business and its sources of net income, as well as its outgoings and financial obligations. It is effectively an analysis of an organisation’s cash flow, and is used alongside other important reports, such as balance sheets and income statements, to paint an accurate picture of an organisation’s financial health.

Cash flow, on the other hand, refers to the tangible amount of cash moving in and out of a business’s bank account. In essence, an organisation’s cash flow is documented in its cash flow statement.

What is the difference between cash flow and profit?

Cash flow and profit are two different metrics that can help demonstrate the health of organisational or business finances.

While cash flow considers the amount of money moving into an organisations’s accounts receivable and out of a business via accounts payable at a particular point in time, profit simply refers to an organisation’s revenue minus its expenses. 

It’s worth noting that one metric is not necessarily indicative of the other. According to QuickBooks, a profitable business may have a negative cash flow, while a business with a positive cash flow may not be profitable:

“Earning revenue does not always increase cash immediately, and incurring an expense does not always decrease cash immediately,” it states. “Therefore, there may be a time when your business’s gross sales are up, even while your business has more cash outflow than inflow.”

Cash flow management

Whether an organisation is a small business run by a single owner, a startup run by entrepreneurs, or a large corporation, cash flow management is as essential as having a solid business plan.

Cash flow management refers to the bookkeeping systems and processes a business puts in place to track and manage its cash flow. This might include:

• Using dedicated software or manual bookkeeping systems to record cash flow.
• Implementing processes for collecting payments and chasing debt.
• Setting payment terms.
• Agreeing appropriate measures for addressing negative cash flow. This might include temporarily relying on credit, including a business line of credit or credit card, considering invoice factoring, or increasing the cost of goods sold to customers or clients.

Build your skills in business leadership

Learn more about business cash flow and all areas of operations management with the University of Sunderland’s 100% online MSc Management programme. This flexible master’s programme has been developed for working professionals who want to advance their careers in leadership and management while continuing to work, so you can study around your current commitments and earn while you learn.

Some of the core modules on this programme cover financial management control as well as operations management, so you will have the opportunity to examine:

• Internal systems for financial management.
• Measures that ensure financial resources – and other resource types – are used in regular, ethical, economical, and effective ways that benefit a business and support its objectives.
• Business practices designed to establish the highest level of efficiency within an organisation. 
• Converting materials and labour into goods and services as effectively and efficiently as possible in order to maximise profit. 
• The theory and practice behind the balancing of costs with revenue in order to achieve the highest possible operating profit.