What is Cash Flow?
Cash flow refers to the movement of cash into and out of a business over a period of time. These movements can be grouped into two basic categories: cash inflows and cash outflows.
Cash inflows are amounts of money entering the business. These might include customer payments, cash sales, collections from previous sales, loans, or money invested in the business.
Cash outflows are amounts of money leaving the business. These might include payments to suppliers, rent, wages, utilities, equipment purchases, loan payments, and other business expenses or cash uses.
When you compare the two, you get net cash flow:
Net cash flow = Cash inflows − Cash outflows
Net cash flow tells you whether more cash came in than went out during a particular period.
But the individual inflows and outflows are still important. A business may receive cash from
customers next month while needing to pay suppliers and other expenses this month.
Why Cash Flow Matters
Imagine that you run a small business selling products to customers. During the month, you make $10,000 in sales and have $7,000 in total costs. On paper, that leaves you with $3,000 in profit.
It may seem like the business is doing well. But suppose some customers bought on credit and will not pay until next month. At the same time, your suppliers require payment this month, your rent is due, and you need to purchase another batch of inventory to keep selling. The business may have earned a profit on paper while having much less cash available in its bank account.
This situation can create a difficult cycle. You need cash to continue operating, but some of the money associated with your sales has not yet arrived. At the same time, cash is leaving the business to pay suppliers, employees, rent, utilities, and other expenses. If you do not pay attention to the timing of these movements, you may experience a cash shortage even when the business appears profitable.
The important question is not only whether the business is making money, but also whether cash will be available when the business needs it.
Start with the basics
Looking at cash inflows and outflows together gives you a clearer picture of what is happening to the business’s available cash.
Cash Inflows and Cash Outflows
Cash inflows and cash outflows do not necessarily happen at the same time. For example, a business might sell $5,000 worth of products in January, but customers may not pay until February. The business has made a sale, but the corresponding cash has not yet entered the business.
Meanwhile, the business may need to pay its suppliers in January. Cash is therefore leaving the business before the cash from those customer payments arrives. This is why looking only at sales or profit may not tell you whether the business has enough cash available at a particular moment.
Net Cash Flow
Once you identify the cash coming in and going out, you can compare them to
determine the net cash flow for a particular period.
Net cash flow = Cash inflows − Cash outflows
For example, if a business receives $8,000 in cash during January and pays out $6,000 during the same month:
$8,000 − $6,000 = $2,000 net cash flow
The business had $2,000 more cash coming in than going out during January.
If instead the business received $6,000 and paid out $8,000:
$6,000 − $8,000=-$2,000 net cash flow
The business had $2,000 more cash going out than coming in during that period.
Net cash flow is useful, but it should not replace an analysis of individual inflows and outflows. Knowing that a business had negative net cash flow does not, by itself, tell you what caused it. Looking at the underlying movements can show whether the difference came from lower customer payments, a large inventory purchase, an equipment purchase, higher operating expenses, or another event.
Cash Can Be Tied Up in the Business
Cash can also become unavailable when it is used for investments that support future sales. Inventory is one common example.
Suppose you spend $4,000 purchasing inventory in January. You have not necessarily lost that $4,000. The inventory may still have value and may eventually be sold for more than it cost. But the $4,000 is no longer sitting in your bank account and cannot be used to pay another bill until the inventory is sold and the resulting cash is collected.
This is one reason growing businesses can experience cash pressure. More sales may require more inventory, supplies, or operating expenses before the business receives cash from those sales.
Imagine a business begins January with $5,000 in cash. During the month, it receives $8,000 from customers and pays $9,000 for inventory, rent, utilities, and other expenses.
The cash movements are:
- Beginning cash: $5,000
- Cash inflows: $8,000
- Cash outflows: $9,000
- Net cash flow: −$1,000
- Ending cash: $4,000
The business therefore finishes January with $4,000 in cash.
The important point is that the business did not simply have “−$1,000 cash flow.” It had $8,000 flowing in, $9,000 flowing out, and a resulting net cash flow of −$1,000.
Work Through Your Own Situation
To understand your cash flow, start by identifying how much cash you expect to have available at the beginning of each period. Then estimate the cash you expect to receive and the cash you expect to spend during that period.
For a simple monthly plan, you can think about four things:
Beginning cash + Cash inflows − Cash outflows = Ending cash
Beginning cash is the amount available at the start of the period. Cash inflows are the payments you expect to receive. Cash outflows are the payments you expect to make. The resulting ending cash is an estimate of how much cash may remain available at the end of the period.
You can also calculate net cash flow separately:
Net cash flow = Cash inflows − Cash outflows
Looking at these numbers together helps you understand both the movement of cash and its effect on the amount available to the business.
Suppose a small business starts January with $6,000 in cash. The owner expects to collect $8,000 from customers during the month and expects total cash payments of $10,000 for inventory, rent, utilities, wages, and other expenses.
The cash flow for January would look like this:
- Beginning cash: $6,000
- Cash inflows: $8,000
- Cash outflows: $10,000
- Net cash flow: −$2,000
- Ending cash: $4,000
The business therefore expects to finish January with $4,000 in cash.
Now suppose February is expected to be slower. The business begins February with $4,000, expects to collect $5,000, but expects to spend $7,000.
The February cash flow would be:
- Beginning cash: $4,000
- Cash inflows: $5,000
- Cash outflows: $7,000
- Net cash flow: −$2,000
- Ending cash: $2,000
Looking at the two months together shows how the business’s available cash is changing. A declining cash balance does not necessarily mean that the business is unprofitable. However, the forecast indicates the business has less room to handle unexpected expenses or delays in customer payments.
Look for the Months That Create Pressure
A cash flow plan becomes especially useful when you look across several periods rather than only one month. You might discover that sales are strong during one part of the year, but expenses increase earlier because you need to purchase inventory in advance. You might also notice that customers usually pay several weeks after receiving your product or service. These patterns can create periods when cash becomes tight even though the business may generate enough revenue over the longer term.
The goal of planning is not necessarily to make every month look the same. It is to understand when cash is coming in, when cash is going out, and how those movements affect the cash available to the business.
Questions worth asking
A cash flow estimate is only as useful as the assumptions behind it. Before relying on the result, look at where your numbers came from and consider how confident you are of them.
- When do customers actually pay, rather than when do I make the sale?
- Which expenses must be paid before I receive the related customer payments?
- Are there months when expenses are likely to be much higher than usual?
- How much cash do I need to keep available for unexpected expenses?
- What happens if sales are lower than expected?
- What happens if customers pay later than expected?
- Are there large purchases or payments coming up that are not part of a normal month?
- Which cash inflow or outflow has the greatest effect on my available cash?
- What would happen to my cash balance if one of my assumptions changed?
These questions can help you see where the pressure in your cash flow comes from. They can also show you which parts of your estimate deserve more attention.
Ready to work through it?
The Cash Flow Planner helps you organize the money you expect to receive and spend over time so you can see how your available cash may change from one period to the next. Instead of looking at sales and expenses as isolated numbers, you can examine cash inflows and outflows and see how they affect your cash balance.
Use your best current estimates, then look at the periods where cash becomes tighter. If the result raises questions, return to your assumptions and consider what information you could gather to make the estimate more realistic. The purpose is not to predict the future perfectly, but to give you a clearer picture of how cash may move through your business.
Open Cash Flow PlannerKeep learning as you go
A cash flow plan is something you can update as your business becomes easier to understand. Your first estimate may be based on assumptions about sales, customer payment timing, expenses, and operating patterns. As actual results come in, you can compare them with what you expected and adjust your estimates.
For example, you may discover that customers usually take longer to pay than you originally expected, that some expenses occur more frequently than planned, or that certain months are consistently stronger or weaker than others. These observations can make your next cash flow plan more useful because it is based not only on what you expect, but also on what you have learned from operating the business.
The goal is not to eliminate every uncertainty. It is to understand how cash moves through your business, recognize periods when cash may become tight, and identify which assumptions you should examine more closely.
You don't have to have everything figured out today. You just need a clearer next step.