How to Understand and Manage Your Cash Flow

June 2019

You certainly know that profit and cash flow are both important elements of a healthy business. But what’s the difference? And what can you do to achieve positive cash flow?

Profit vs. Cash Flow

Profit is defined as revenue minus expenses. It may also be referred to as net income. Cash flow, on the other hand, refers to the inflows and outflows of cash for a particular business. In other words, profit is how much money your business is making when all is accounted for, but cash flow is how much money you currently have access to.

For small businesses, positive cash flow is the goal. You want to generate more money than you’re spending. And while this sounds simple, plenty of profitable businesses run into cash flow problems. It can be challenging to balance regular expenses like salaries, rent and technology with irregular revenue. Your sales might be strong, but if cash is stuck in inventory or accounts receivable, you have a cash flow problem.

So, what can you do to manage cash flow? Cash flow statements, along with balance sheets and income statements, help provide insights into a company’s finances. Unfortunately, many business owners do not access a cash flow statement and they only rely on the balance sheet and income statement to help manage their finances.

Income Statement vs. Cash Flow Statement

An income statement, also known as a Profit & Loss (P&L) report, shows the bigger picture of how much money your business makes and spends within a given time period. In other words, it summarizes how your business earned revenue, paid expenses, and arrived at its bottom line.

Income statements account for financial factors beyond cash flow, non-cash expenses such as depreciation, and allow you to observe your business’s longer-term trends in spending and earning. Your income statement can help you answer questions such as: How did my business perform last year? Where can I cut back on costs? Will lenders trust me to repay their financing?

A cash flow statement shows the incomings and outgoings of your business’s cash within a given time period. It provides the shorter-term information you need on a daily basis. Your cash flow statement can help you answer questions such as: Can I afford to pay my bills? Do I have enough cash for unexpected equipment repairs? Will I be able to fund payroll on time?

Cash flow statements typically divide cash by use:

Financing: Cash used for borrowing or lending
Operations: Cash used during daily operations
Investing: Cash used to purchase equipment or other assets
Income statements and cash flow statements present different, yet related, information. The full financial picture of your company is incomplete without understanding both.

How to Plan Your Cash Flow

Higher profits are a great objective, but meeting the cash needs of your business requires careful planning. Staying in the green can be difficult, especially for startups and small businesses. Here are a few suggestions for staying on top of your cash flow:

Review cash flow statements to help understand the inflow and outflow of cash.
Create budgets to help forecast where you are at and where you would like to be.
Establish a line of credit to provide cash when needed. Addressing a cash flow problem is sometimes as simple as unlocking cash tied up in accounts receivable.
You can learn more about cash management methods here.

We know that understanding the importance of cash flow management is key to your business’s survival and success. If you need help managing your cash flow, please don’t hesitate to call RBI member, Cray Kaiser.