What is cash flow? Definition, how to improve it, and more

Cash flow is the lifeblood of your business, sustaining your operations and allowing you to pursue your growth ambitions. 

Whether you’re interested in how to start a business from home, or running a customer-facing business like a brick-and-mortar shop or café, every business of every size needs to keep an eagle eye on cash flow. Indeed, getting the hang of cash flow management can be essential to your ongoing success.

In this guide, we’ll define cash flow and why it’s an integral component of bookkeeping for small businesses. We’ll also delve into how accurate cash flow analysis can underpin the key decisions you make as an entrepreneur, on everything from what products and services you offer, to your operations management strategies.

What is cash flow?

Let’s start with the cash flow definition: it is the measure of cash coming in and out of your business over a specific period. This includes everything from revenues you generate from things to make and sell, through to money you spend on operations and investments.

You might be launching full-time business ideas from home, trying out side hustle ideas, or taking an existing business to the next level. Whatever your precise situation, cash flow analysis helps you understand your liquidity, revealing whether you’re sitting comfortably with cash, just getting by, or losing money at an unsustainable rate.

Why cash flow is important

As we’ve already touched on, managing cash flow should be a major item on your to-do list as an entrepreneur. So, just why is cash flow important to a business? Let’s run through key reasons why you should keep up with the numbers.

It gives an insight into financial health

First and foremost, tracking cash flow is key to assessing your business’s financial health. 

Whether you’re exploring low cost high profit business ideas from home or scaling a more complex venture, cash flow analysis will tell you if your decisions are having a positive or negative impact on your financial resources.

It can inform strategies

With a clear understanding of your business’s finances, you’ll be all set to make informed decisions on issues like pricing strategies and how to get clients. This clarity ensures that your every move is aligned with boosting your bottom line.

Perhaps you run a craft supplies shop. Analysing cash flow might show that your pre-recorded online crafting courses drive significant sales. This could lead you to invest more in these passive income ideas, directly responding to what brings in revenue.

Or, let’s say you’re running a restaurant and notice a consistent increase in cash flow on weekends but a drop mid-week. This insight could lead you to introduce mid-week specials or events, boosting revenues when you need it most. 

To take yet another example, imagine you own a florist shop experiencing a seasonal sales dip. By monitoring cash flow, you can quickly adapt, perhaps introducing special workshops to boost revenue. The cash flow insight therefore transforms an ostensibly negative turn into fresh business opportunities.

It can help fuel growth

Your cash flow can indicate when and how much to invest in growth strategies. 

If you’re a builder who’s anticipating a busy summer period, analysing cash flow will let you know how much of your small business budget you can allocate for extra staff and materials in advance, ensuring you can take on more projects without compromising quality or financial stability.

Or, if you run a physical retailer and want to generate more income streams through online business ideas, you can decide how much to spend on these new avenues based on your cash flow analysis.

It can help boost credibility

Effective cash flow management can enhance your credibility with banks and investors. This is especially important if you’re considering small business crowdfunding opportunities or exploring expansion options.

Having a solid grasp of your cash increases your appeal to those who can provide a financial leg up.

For instance, a healthy cash flow forecast can help investors figure out how to value a business. It doesn’t just show you’re doing okay right now, but also proves you’ve got what it takes to grow and make more money down the line.

Types of cash flow analysis

There are two main ways in which small business entrepreneurs can conduct cash flow analysis: cash flow statements and cash flow forecasts. Let’s look at these in turn.

Cash flow statement

A cash flow statement is akin to a detailed financial diary for your business. It records all the cash transactions to have taken place over a specific period, such as a month or a quarter.

A cash flow statement typically has three main parts:

• Cash from operating activities 

• Cash from investing activities 

• Cash from financing activities

Operating activities

Cash flow from operations relates to your core business activities. It looks at what brings in revenues, such as the sale of goods and services. It also shows what you’re spending to keep things running, such as supplier costs and the wages you pay to your team.

Essentially, operating cash flow considers the day-to-day stuff, and is the most direct reflection of how viable your business is.

Investing activities

This section of your cash flow statement tracks small business finances related to investments. This will include cash spent on upgrading your tech, cash made from selling off equipment, and cash flow related to buying or selling stocks and bonds.

Whether you’re investing in a new self-service kiosk to cut queues and boost order values, or ploughing some of your profits into state-of-the-art app development, it will all appear here. 

Financing activities

This part of your cash flow statement gets into the nitty-gritty of how you fund your enterprise and pay back those involved in the enterprise. It’s where you’ll list dividends distributed to shareholders, loans received and paid off, and the cut of revenues given to investors.

Let’s say you run a café and decide to take out a bank loan to cover the costs of kitchen equipment; that loan would show up as an inflow, while the repayments would later show up as outflows. would show up here. Simply put, this section reflects the financial choices you make to support and grow your business.

Summing up

Adding the totals of these parts together gives you your bottom line – your net cash flow.

But what is net cash flow? It’s simply the total change in your business’s cash position from one period to the next.

If you've got a positive net cash flow – more cash coming in than going out – it’s a good sign your business is doing things right. But if you're seeing less cash, it might be time to think about tightening up or exploring how to make money on the side.

But remember, not all cash dips are bad news, especially in the early stages of setting up a limited company. Rather than being a red flag, a negative number may simply reflect the fact you’re investing in the future. Be sure to look beyond the numbers and get the full picture.

Positive or negative, adding your net cash flow to your opening balance – the cash you had at the start of the period – tells you how much cash you have at the end of the accounting period.

Cash flow forecast

Where a cash flow statement looks back, a cash flow forecast looks forward, shifting the focus from past performance to future possibilities. This helps you anticipate the flow of cash in and out of your business and plan with greater certainty.

Cash flow forecasting is typically based on a combination of past cash flow patterns gleaned from your cash flow statements, and your predictions for the coming periods. As with statements, forecasts can cover a range of timescales; anything from daily to yearly will work, though they tend to be less accurate the further out you look.

Cash flow forecasts have three main sections:

• Cash inflows

• Cash outflows

• Net cash flow

Cash inflows

This section focuses on the money expected to enter your business, and should reflect your track record so far along with any increases or decreases you might be expecting.

For example, if you’re learning how to use social media for small business success, the estimated uptick in revenue based on boosted sales will be recorded here.

The section also covers alternative funding sources, like tax rebates for energy-efficient business practices, small business grants for tech upgrades, or bank loans.

Cash outflows

This section predicts how much money will be leaving your business. Here, you’ll account for small business expenses like utility bills and payroll, as well as any planned investments in improving customer experience, such as the purchase of new card readers or sales management systems like POS Pro.

This section also tracks marketing expenses aimed at improving customer retention, along with things like essential subscriptions and insurance. It covers your employee retention efforts too, anticipating costs associated with how to motivate employees, like team-building days or monthly gift cards for top performers.

By keeping a detailed record, you ensure no expenditure slips through the cracks, providing a clear view of your financial commitments.

Net cash flow

Net cash flow offers a look at your financial status by comparing inflows to outflows. It’s a key indicator of your business’s expected liquidity, revealing whether your strategies – from plans for how to advertise your business to new customer loyalty initiatives – look set to pay off.

As with cash flow statements, a positive net cash flow is good news. It means you can expect more cash to come in than go out. Conversely, a negative balance might prompt a strategic review, encouraging you to think about how to improve cash flow to cover any anticipated shortfalls.

The expected net cash flow can be important when you’re looking into how to write a business plan to secure investment, and when you’re conducting a SWOT analysis for small business to investigate the strengths and weaknesses of your enterprise.

Combining cash flow tools

By mixing the retrospective insights from cash flow statements with the predictive power of cash flow forecasts, you create a comprehensive overview of where your business stands when it comes to cash.

Conducting both types of analysis can arm you with the knowledge to pinpoint opportunities for growth, and make informed decisions about how to scale a business or manage your resources for long-term stability.

Remember that getting a grip on cash flow is much easier when you’ve got the right tools. You can find free cash flow statement and cash flow projection templates online, which are perfect for getting these documents up and running without dipping into your wallet.

These free cash flow templates are usually simple to use, guiding you effortlessly through summarising past transactions and predicting future cash movements.

To make things easier still, you’ll find that plenty of accounting tools for small business go beyond crunching numbers. Many include smart cash flow features that pull your financial information together automatically. This means less time tracking every penny and more time focusing on the big picture.

And if you’re looking for something tailor-made for cash flow, there are apps and software out there designed just for that. These specialised tools dive deep into your finances, offering insights and tips on how to keep your cash flow healthy and your business growth strategies sharp.

How to manage cash flow

Effective cash flow management goes beyond simply tracking what comes in and goes out; it’s also about planning for growth and keeping things stable in the future. 

Whatever sector you’re in, whether you run a hospitality business, run online store or something else entirely, here are five tips to help you stay on top of your cash.

• Understand your cash flow cycle – recognise peak seasons and slower periods, especially if you’re in food and drink or retail. This knowledge helps you anticipate cash needs and plan accordingly.

• Optimise your inflows – use technology such as contactless card machines and smart invoicing tools to keep the cash flowing. 

• Monitor your expenses – regular reviews can reveal opportunities to cut costs or identify where spending more could generate income, like investing in your marketing strategy for small business.

• Optimise inventory – managing stock properly can free up cash. Overstocking ties up funds, while understocking can lead to missed sales. Aim to balance stock levels with demand without tying up too much cash. 

• Review often – quick looks at your cash flow at regular intervals help you spot problems early, adjust plans, and keep cash levels healthy. This helps you stay ready to make changes as needed.

How to improve cash flow

Keeping your cash flow in good health is key to business success. In the table below, you can explore some of the main methods for improving cash flow across three areas: revenue, operations, and capital.

For example, if you’re thinking about how to make extra money from selling your goods and services, you might consider introducing a customer loyalty program or referral scheme, or think about how to price a product or how to price a service so that they bring in more cash.

On the operations front, improving efficiency could involve exploring how to do a payroll more effectively, perhaps via specialist software to save time and reduce errors.

In terms of capital, optimising your assets might include strategies like rotating inventory faster to prevent your money from being tied up in unsold stock.

CASH FLOW

Cash flow is key for all types of businesses

We’ll wrap up with a reminder that understanding cash flow is essential whatever business you’re launching. Whether you’re exploring how to start a side hustle or considering how to start an online business, managing cash effectively from the outset can help you turn your ideas into reality.

Of course, cash flow management is not just for startups, but also for established businesses hoping to prosper. By mastering cash flow, you're better positioned to take advantage of new opportunities, from launching new products to expanding your presence online.

Disclaimer: The contents of this page are intended for informational purposes only and should not be construed as professional advice. For matters requiring legal or financial expertise, it’s recommended to seek guidance from qualified professionals.