What is cash flow?

Cash flow is the term used for the money that comes into, and goes out of, a business. It describes the net amount of money involved in this process. The income received is known as inflows and the cash paid out is called outflows.

Cash flow is important within a company’s financial reports. Among other things, it helps to establish the health of its liquidity.

Knowing the cash flow of a business is vital for shareholders and investors. In order to create value for their investors, businesses must be able to produce and show proof of positive cash flows or free cash flow (FCF).

To increase liquidity, a business must have a positive cash flow. This shows it can:

• Easily account for all its financial outgoings
• Protect itself from potential adversity
• Reinvest
• Deliver shareholder returns.

Different ways money can flow into and out of a business

Inflows of money can come into a company via:

• Sales and revenues
• Interest
• Investments
• Royalties
• Licensing agreements.

Money can go out (outflows) via expenses, including:

• Interest payments
• Income tax payments
• Salary and wages
• Rental costs
• Supplier payments
• Investments – including asset purchases, for example.

The two main types of cash flow are called positive cash flow and negative cash flow.

When a business has a positive cash flow, it means more money is coming into the company than going out. In contrast, a negative cash flow describes a business with more money going out than coming in.

Specific types of cash flow can also cover different business activities, including:

• Operating cash flow (CFO) – the flow of money within a business’ normal operations, including the sale of goods. Operating cash flow should have more inflows than outflows to ensure financial health over a long period.
• Investing cash flow (CFI) – the money a company generates from its investments. Negative cash flow in this area isn’t usually considered a concern as a business may have investments in place with the future in mind.
• Financing cash flow (CFF) – the flow of money used to finance the business from its owners and investors, or even its creditors. CFF can show investors and stakeholders how healthy a company’s capital structure is.

Cash flow management is simply measuring your cash flow over a specific period to work out costs versus revenue.

This process keeps track of the funds that come into your business and observes these figures compared with outgoing funds. The aim of cash flow management is to ensure your business is turning a profit while meeting all other obligations, such as bills.

The benefits of good cash flow management include:

• The reduction of stress – Financial issues can contribute to stress felt by those who run small businesses, says the British Association for Counselling and Psychotherapy (external link) [1]. Good cash flow management can help to ease that financial burden.
• Forecasting shortfalls – good cashflow management can help with planning and preparation for all eventualities. As credit referencing agency Experian says, ‘it gives you a complete picture (external link)’ [2] of what’s coming in and going out.
• An understanding of when to push for growth – rather than spending on expanding your business when you’re not ready, cash flow management can offer a guide. Writing in Forbes (external link) [3], Steve Smith says it’s ‘essential to sustaining long-term growth’.

Cash flow is a priority when running a small business. Many factors can affect this, so it’s useful to know how to improve cash flow management.

Struggling to know where to start with small business cash flow? Colin Hewitt, CEO of Float, a cash forecasting tool, has shared his top tips to improve and manage your business’ cash flow.

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1. Get forecasting

Keep tabs on your finances, whether it’s with a spreadsheet or an online forecasting tool. Set budgets, check you’re sticking to them, assess the effect new hires will have on your cash flow, and make it easier to foresee when late payments could cause problems.

If you ensure you’re always aware of when finances are coming and going, you can make a contingency plan and know how to solve cash flow problems.

Cash flow forecasting explained

2. Invoice on time

Send an invoice as soon as work is complete. Use emails for speed and record-keeping, and don’t be afraid to chase late payments. Be charming but persistent; if you’ve done the work, you deserve to be paid.

Spend time early on creating an invoice template that looks professional, contains all the necessary details for tax and legal purposes, and clearly states who owes what and when.

3. Negotiate terms

Big clients are known for slow payments. Ideally, you should get suppliers to pay within a fortnight – but try to avoid terms longer than 30 days.

Balance profit margins with quick payments. Don’t underestimate the value of gaining small clients who pay on time, even if you don’t make quite as much from your business with them.

4. Build a cash reserve

If you can, put some money aside. It could help you put in a big order for stock at a discounted price, or enable you to take on a new client without needing to delay while you borrow.

Start-ups need to be able to cough up a lot of one-off payments – equipment, deposits, decorating bills, staff uniforms, insurance, you name it – which makes a buffer even more essential.

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Understanding what cash flow is can be crucial for any small business owner. Maintaining a positive cash flow is a priority for the long-term health of a company and there are many benefits to good cash flow management. A solid plan can help reduce stress, forecast shortfalls, and indicate when it’s safe for you to push for growth.

In fact, Colin Hewitt, CEO at Float, advises coming up with a plan and sticking to it:

^{“The best advice we could give is to set budgets and stick to a plan, make sure your invoices are being paid on time and do a forecast to find out how much cash you will have in the coming weeks, months or years.}

^{“Forecasting shows you the health of your business and helps you secure investment. It’ll also help you decide how much you can reinvest and plan for any cash gaps that might arise.”}

Check out our video to avoid any cash flow surprises:

In addition to mastering cash flow, there’s plenty more to learn when starting up. From learning about PAYE tax to exploring ideas for funding your business.