business cash flow

Understanding business cash flow

When running your business, you need to know how your money is moving around. Understanding your business cash flow gives you insights on how to spend your hard-earned money effectively to scale your business. If you don’t manage your business funds properly, you may end up in a hole that’s hard to recover from. Luckily, there are ways to solve cash flow problems and manage your money efficiently. Creating a monthly cash flow statement can help you organize your business expenses, understand your business spending habits, and identify areas where you can reduce operating costs. There are also Canadian business loan options available that can provide you with working capital to cover necessary business expenses.

Cash flow can be complicated, but it doesn’t have to be. In this comprehensive guide, we want to teach you everything you need to know about business cash flow, including:

  1. What is cash flow?
  2. How is a cash flow statement organized?
  3. Why is cash flow management important?
  4. What are some common cash flow mistakes?

1. What is cash flow?

Cash flow is the net amount of money that moves into and out of your business in a given time period. Most business owners track their cash flow on a monthly basis.

Cash flowing into your business is typically generated from the sales you make. It could also result from any business financing you’ve obtained, returns on business investments you’ve made, or returns on assets you’ve sold.

Cash flowing out of your business is money you’re spending to run your business. This could be money spent on inventory, supplies, and rent. It could also be money spent on investing in property or equipment. If you’ve received business financing, loan repayments would also be included here.

If you end a month with more money in the bank than when you started, your business cash flow is positive. For example, your monthly cash flow could be positive because the total cash made from sales is greater than the total amount of money you’ve spent paying bills.

If the opposite happens, your business cash flow is negative. For example, even if your monthly sales are high, your cash flow could be negative if you have large bills to pay. Being cash flow negative is a red flag you should be aware of.

Having positive cash flow is important because you’ll have an easier time paying your bills, making long-term investments, and dealing with unexpected setbacks that require you to spend cash. An effective way of measuring your cash flow is by creating a monthly cash flow statement.

2. How is a cash flow statement organized?

Put simply, a cash flow statement is a ledger that outlines all your cash inflows and outflows. When measuring your monthly cash flow, you can organize your cash flow statement into three main categories:

  • Operating cash flow activities
  • Investing cash flow activities
  • Financing cash flow activities

Operating cash flow activities

Operating cash flow is your business’s bread and butter. Operating cash flow data shows the revenue you generate from day-to-day business operations. It also shows the costs you incur when generating that revenue. Your operating cash flow is an important indicator that shows how efficiently you’re running your business. You can calculate your total operating cash flow by subtracting your operating cash outflows from your operating cash inflows.

Your typical operating cash inflows include:

  • Cash received from selling your products or services

Your typical operating cash outflows include:

  • Inventory purchases
  • Employee payroll
  • Advertising costs
  • Rent and utility payments
  • Other operating expenses

Operating cash flow shows how much money you make or lose on basic business operations. Lenders and potential investors might ask for this cash flow data to see how successful your day-to-day operations are. You want your operating cash flow to be positive. You should measure your operating activities to:

  1. See how much money you’ve generated from sales
  2. Understand what operating expenses you’ve incurred to make those sales
  3. Analyze which operating expenses to cut back on

Investing cash flow activities

Investing cash flow data shows how much money you’ve spent investing in property, equipment, or technology. It also shows how much cash you’ve gained from selling any of these fixed assets. You can calculate your total investing cash flow by subtracting your investing cash outflows from your investing cash inflows.

Your typical investing cash inflows include money gained from:

  • Selling property
  • Selling buildings
  • Selling equipment
  • Selling company vehicles
  • Other money gained from selling fixed assets

Your typical investing cash outflows include money spent on:

  • Buying property
  • Buying buildings
  • Buying equipment
  • Buying company vehicles
  • Other money spent on buying fixed assets

Investing cash flow shows how much money you are spending or gaining on long-term business investments. Having negative cash flow from investments isn’t necessarily a bad thing. This is because you’re using cash to invest in long-term growth plans for your business’s future. Lenders and potential investors might ask for this cash flow data to see how you’re investing in your business’s future. You should measure your investing cash flow activities to:

  1. Understand how much money you’ve spent on fixed assets
  2. See how much money you’ve earned from selling older fixed assets
  3. Analyze opportunities to invest in or sell your fixed assets

Financing cash flow activities

Financing activities are your capital raising activities. Financing cash flow data shows the money you received from banks or other lenders to finance your business. This includes small business loans, merchant cash advances, business lines of credit, or other forms of small business financing. This data also shows how much money you’ve spent to repay your lenders. You can calculate your total financing cash flow by subtracting your financing cash outflows from your financing cash inflows.

Your typical financing cash inflows include:

  • Cash received from loans or alternative financing products
  • Cash received from investors
  • Other cash received from financing sources

Your typical financing cash outflows include:

  • Loan payments
  • Investor payments
  • Other debt and financing payments

Financing cash flow shows how much money you’re receiving from lenders and investors. It also shows how much cash you’re using to pay off debts. This cash flow data is critical information for lenders and potential investors. Lenders want to know that your business can make repayments on time when they offer you a business loan. You should measure your financing cash flow activities to:

  1. See how much money you’ve received from loans and other financing
  2. Understand what financing debts you need to pay off
  3. Analyze whether your business has enough money to pay of existing debt or take on new debt

3. Why is cash flow management important?

Demonstrating strong cash flow management is an important aspect of running a successful business. Just because you’re earning revenue doesn’t mean that you have enough money to pay your bills and stay afloat. Industry Canada research estimates that 30% of Canadian small businesses don’t survive past 2 years. An additional 20% don’t make it past 5 years.

In fact, according to Industry Canada, 3,580 businesses filed for insolvency in 2018. Cash flow problems are a major contributor in Canadian small businesses falling under. Here are some key reasons why monitoring your cash inflows and outflows is important:

You can understand your business spending habits

Monitoring your entire cash flow allows you to understand your spending habits and re-evaluate your business expenses. If you only monitor your sales, certain expenses may go unnoticed and end up becoming a large financial burden for your business.

By analyzing your spending habits, you might find opportunities to decrease your operating and investing expenses. Perhaps you can cut back on utilities by lowering your energy consumption. Maybe you’re overspending on your internet plan with your current provider and can find a more affordable vendor. You might have unused inventory or equipment that you can sell to gain a cash injection. Cash flow management gives you a holistic view of your business spending habits and provides you with opportunities to optimize them.

You can compare inventory purchases to sales

If you’re a retailer, a restaurant owner, or run a food and beverage store, you need to have the right goods stocked up for your customers. Meeting customer demand by serving the right products is important, but you want to make sure you’re not overspending on inventory.

Cash flow management gives you a clear view how much money your business generates from sales and how much money your business spends on stocking up inventory. If you notice that your inventory purchases are overshadowing your sales, you should consider cutting back on your inventory spend. You may also want to analyze what inventory you’re overspending on in comparison to which products or goods are underselling. Optimizing your inventory spend is essential for ensuring your operating cash flow remains positive.

You can plan big equipment purchases

Monitoring your cash flow regularly allows you to plan ahead when it comes to making large business purchases. Big-ticket items such as equipment and work vehicles might be essential for running your business. That said, you want to make sure you’re not overspending all at once.

Cash flow management gives you insights on where you’re currently investing your money. You can determine what fixed assets your cash may be tied down to. You can also use this data to create a roadmap for staggering big purchases over time. Staggering necessary equipment purchases can give your business time to recover from large cash outflows, allowing you to maintain a healthy overall cash flow.

You can anticipate seasonal fluctuations

Certain businesses experience seasonal peaks and dips in sales. Capitalizing on seasonal peaks is important, but being prepared for seasonal dips is even more essential.

Managing your cash flow can help you prepare for these seasonal fluctuations. If you notice that money is tight for certain months in the year, you can take preventative measures to ensure your business has enough cash on hand. Planning ahead with small business financing solutions can help you save time and stress during slow sales periods.

4. What are some common cash flow mistakes?

Not managing your cash flow can lead to certain expenses going unnoticed. These expenses can pile up and become a large financial burden, causing you massive headaches. Here are some common cash flow mistakes, along with ways to fix them.

Overstocking on inventory

Managing your inventory and supplies can be a difficult task. As a business owner, you want to make sure you have enough goods in stock to satisfy your customers. You also want to make sure your money isn’t tied down to unused or wasted inventory. If a large amount of your business funds is bound to unpurchased inventory, you may have a tough time scaling your business.

For example, you might run a restaurant and spend $300 monthly on tomatoes. If you only use $100 worth each month, you’re wasting $200 that you could use for other business expenses.

Analyzing your monthly purchases can give you some guidance on how much of your money is tied down to unused inventory. If you find yourself struggling with idle inventory, consider the following tactics:

  • Decrease prices or offer special discounts on idle inventory
  • Rebalance inventory purchases to focus on items that are guaranteed to sell
  • Revise order cycles so you’re not over-purchasing each month
  • Reconsider how much product to keep in stock

Overspending on operating expenses

Operating expenses add up quickly, and they can harm your business if they go unnoticed. Even if you have great sales volume, you might have trouble breaking even if your operating expenses eat up a large amount of your cash flow. Utility bills, internet service, and payroll are just a few operating expenses that could be weighing down your business.

Analyzing your monthly cash flow can help you re-evaluate expenses and identify areas to cut back on. You may be spending your hard-earned cash on areas that aren’t the highest priority. You may also be spending money outsourcing work that you could be doing in-house. Instead of hiring an accountant to record your business’s transactions, do your own bookkeeping. Instead of hiring a marketing agency to manage your social media accounts, take control of your own accounts.

Create a hard budget for your daily operating expenses, and stick to it. This will help you ensure that you’re not overspending to run your business. If you notice your operating expenses are beginning to increase, don’t panic. There are actions you can take to address increased expenses. Consider applying for a business loan to gain the financing needed to cover your operating expenses.

Making equipment investments too quickly

Expensive equipment may be necessary to run your business, whether it is an auto shop or a beauty salon, to name a couple of examples. You want to make sure you’re not making large equipment investments too quickly. Tying up a large portion of your business funds to equipment investments can leave you in a bind if you need to quickly cover unexpected expenses.

Analyzing your monthly cash flow can provide you with insights on when to make equipment purchases. When reviewing your investing activities, consider the following tactics:

  • Select business milestones that you need to meet before making additional equipment investments
  • Identify unused or underused equipment that you can sell to generate cash flow
  • Create a dedicated budget that’s solely for equipment purchases
  • Stagger your equipment purchases so that your business has time to keep up

Lumping all your payments together

When running your business, you may need to make regular payments to vendors, suppliers, and lenders. Managing when to make these payments can be tricky. Making payments on time is essential for building your business credit. But if you schedule these payments all at the same time, you’ll be draining your business bank account and eating up too much of your business funds all at once. Spacing out your payments is essential for managing your cash flow effectively.

Using cash flow statements to manage your payments can help you maximize your cash flow while minimizing strain to your business. Consider the following tactics:

  • Set aside time to review your bills, invoices, and accounts payable reports
  • Organize payment due dates in a calendar so you can strategically time your payments
  • Prioritize payments based on who you owe, how much you owe them, and due dates
  • Look for discounts offered by any of your suppliers

Not keeping a cash buffer

Having rainy day funds set aside is important, especially for small business owners. You never know when seasonal fluctuations or accidents could harm your business. If business is slow for a few months, you want to make sure you have enough money to keep the lights on. If a pipe suddenly bursts and forces you to make repairs, you want to make sure you have what you need to get your business up and running again.

Cash flow management can help you identify how much extra cash you should have as a buffer for your business. Consider the following tactics:

  • Apply for business financing to help you manage sudden costs and seasonal fluctuations
  • Set aside funds to cover at least two months’ worth of operating expenses
  • Set aside emergency funds to cover unexpected repairs

Keep your business cash flow circulating

Now you know exactly what business cash flow is, how it’s organized, why cash flow management is important, and some common cash flow mistakes that business owners face.

If you’re worried about keeping your cash flow positive, there are ways to inject your business with quick and effective cash. Thinking Capital can provide your business with well-timed financing. Applying for financing from Thinking Capital is a quick and painless process. You can simply apply online in under 10 minutes. Once you have completed the application, expect a verification call in as little as 30 minutes. If everything goes well, you can have your upfront capital deposited straight into your business bank account in as little as 24 hours.

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