what is cash flow

This is the first installment in our Cash Flow 101 series—our ultimate guide to help you understand and manage your business’s cash flow, and prevent future cash flow problems.

What is cash flow? A definition

Cash flow measures how much money is moving into and out of your business during a specific period of time.

Broadly speaking, businesses bring in money through sales, financing, and returns on investments—that’s cash flowing in.

And they spend money on supplies and services, as well as utilities, taxes, loan payments, and other bills—that’s cash flowing out.

Being cash flow positive means that more money is coming into your business than is going out of your business.

Being cash flow negative means more money is leaving the business than you have coming in.

The easiest way to think about cash flow is to think about the total amount of money that moved into or out of your business checking account during a month. If you finish the month with more cash in the bank than when you started, your business is cash flow positive. If you have less cash at the end of the month, your business had negative cash flow.

Why monitoring cash flow is important for small businesses and startups

Running out of cash 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.

When you measure your business’s cash flow, you are keeping track of how much actual cash is moving in and out of your business so you can ensure that your business is staying healthy. If you’re the type of business that invoices for your work or product after you’ve delivered and there’s a lag time while you wait to get paid, keep in mind that accounts receivable (money you are owed) isn’t the same thing as cash until you actually have those dollars in hand.

Why cash flow forecasting is key

You’ll want to monitor your cash flow monthly so you can start spotting trends in what’s actually happening with your cash inflow and outflow. But it can be even more important to forecast your cash flow so you can anticipate when your business might run low on cash in the future.

You can then plan ahead and open a business 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 actuals for the month on your cash flow statement, 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 financials, like 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.

Cash versus revenue and profits

It’s possible for your business to be profitable but run out of cash. That may not be intuitive at first, but it’s because cash and profits are very different things.

The difference between cash and profits:

  • Profits can include sales (revenue) that you’ve made but haven’t been paid for yet, also known as accounts receivable.
  • Cash, on the other hand, is the amount of money you actually have in your bank account. 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,” you could have lots of revenue on paper but not a lot of cash in your bank account because your customers haven’t paid yet.

If the money your customer owes you hasn’t yet made it into your bank account, it won’t appear on your cash flow statement. It hasn’t flowed in our out of your business yet. It’s still in your customers’ hands, even though you’ve invoiced them for it.

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.

Ready to skip ahead and create your own cash flow statement? Download our free cash flow template now.

Free cash flow template download

How to analyze cash flow

When you’re analyzing your cash flow, 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 it on different time frames, like quarterly, but a good rule of thumb is that look at your cash flow more often is better.

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:

  • Pay your bills. Positive cash flow ensures employees get checks during each payroll cycle. It also gives decision makers the funds they need to pay suppliers, creditors, and the government.
  • Invest in new opportunities. Today’s business world moves quickly. When cash is readily available, business owners can invest in opportunities that may arise at any given point in time.
  • Stomach the unpredictable. Having access to cash means that whenever equipment breaks, clients don’t pay their invoices on time, or new government regulations come into effect, businesses can survive.

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 business 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 $1500 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 have relied 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. 

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.

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.

Read next:

Editor’s note: This article was originally published in 2015. It was updated in 2019.

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Noah Parsons
Noah Parsons

Noah is currently the COO at Palo Alto Software, makers of Outpost and the online business plan app LivePlan, and content curator and creator of the Emergent Newsletter. You can follow Noah on Google+ or on Twitter.