Cash flow is critical to the success of every business. Today, we’ll explore how cash flow impacts a company’s financial decision-making and overall economic wellbeing and provide some fundamental information and specific guidance on managing cash flow.

What is Cash Flow

Simply put, cash flow is the money that flows into a business—also known as “inflows”—and the money that flows out of a business—also known as “outflows.” Every business, regardless of size, must track where the money it receives comes from and how that money is being used over time. This information is prepared and presented in monthly or quarterly cash flow reports and in annual cash flow statements.

But don’t confuse cash flow with revenue and income. Revenue is the total amount of money a business takes in from selling products or services. It doesn’t take expenses into account. Income is the amount of earnings left over when expenses are deducted from revenue.

The Main Purpose of Cash Flow

For businesses to operate profitably, they must have a firm grasp of how much money they’re earning and spending—wanting to make sure more money comes in than goes out. Understanding cash flow enables businesses—as well as investors and creditors—to assess their financial health and determine whether they can:

• Pay short- and long-term debt.
• Reinvest in the business.
• Compensate shareholders.
• Cover all operating expenses (e.g., suppliers, employees, rent, etc.).
• Allocate funds for potential future financial needs.

The Three Types of Cash Flow

Cash flow comes from three main sources: operations, investments, and financing.

1. Cash Flow from Operations

This is the money spent on producing goods (e.g., inventory, materials, and labor) and the cash received for selling those goods. This cash flow indicates whether a business is financially able to maintain or expand its operations and lets business leaders know if external financing is needed.

2. Cash Flow from Investments

This is the money spent on and made from various types of business investments—like investments into tangible assets, securities (e.g., stocks and bonds), and research and development (R&D).

3. Cash Flow from Financing

This is the cash used to fund a business, including debt, equity, and dividend transactions. Businesses use this information to share their debt-to-equity ratio with investors, who focus largely on the companies’ current and future profitability.

Businesses can calculate each type of cash flow (see next section) and use that data to make crucial operational and financial decisions. For example, let’s say a single restaurant wants to become a chain. Before they can move forward and open another restaurant, the leadership team must know how much cash the current restaurant generates from operations, investments, and financing. This will show them whether they have enough money to cover the initial and future expansion costs.

Calculating Cash Flow

According to NerdWallet, you can calculate net cash flow by following a simple formula:

Total Cash Inflow – Total Cash Outflow = Net Cash Flow

Here’s the breakdown:

1. Choose the period of time you want to calculate for—a specific month, quarter, etc.
2. Determine the total amount of cash in your business accounts. This is your opening balance.
3. Add up your inflows for the chosen period. This includes any money that has come into your business from cash sales transactions, sales of assets, loans, transfers, etc.
4. Add the inflows to the opening balance. This will give you your total cash inflow.
5. Add up your outflows for the chosen period. This includes any money that has left your business, like payments for operational, investment, and financial expenses (inventory, salaries, overhead, taxes, loans, and bills). This will give you your total cash outflow.
6. Subtract the total cash outflow from the total cash inflow. This will give you your net cash flow

But measuring the financial health of your business requires knowing more than just net cash flow (NCF). You should also calculate operating cash flow (OCF), cash flow from investing (CFI), and cash flow from financing activities (CFF). American Express provides good formulas for making these calculations:

Operating Cash Flow

OCF shows how your company generates cash from its daily operations.

Net Income + Non-Cash Expenses – Change in Working Capital = Operating Cash Flow

Cash Flow from Investing

CFI shows how your company is allocating money for long-term benefits.

Purchase/Sale of Property and Equipment + Purchase/Sale of Other Businesses + Purchase/Sale of Marketable Securities = Cash Flow from Investing

Cash Flow from Financing Activities

CFF shows how much funding your business is generating over time.

Cash Inflows from Issuing Equity or Debt – (Dividends Paid + Repurchase of Debt and Equity) = Cash Flow from Financing

The Basics of Creating a Cash Flow Statement

Since 1988, the Financial Accounting Standards Board (FASB) has required US businesses to create cash flow statements on a regular basis. These statements summarize the inflows and outflows of a business’s cash transactions. They let businesses know how much cash they bring in and spend, see changes in cash transactions, and view asset availability over a specific period of time. This knowledge—alongside data from income statements (which show profitability) and balance sheets (which show total assets and liabilities)—is then used to determine where a business is in terms of liquidity and long-term solvency.

To create a cash flow statement, a business must choose between two methods: direct or indirect. According to the employment website Indeed, the direct method (or the income statement method) “considers all cash receipts and payments, including cash receipts from customers, payments to suppliers and employees, and income taxes and interest paid.” The indirect method “uses accrual accounting information and includes revenue and expenses when a transaction occurs rather than when payments occur.”

Then, it’s time to calculate cash flow from operating, investment, and financing activities using the formulas noted in the previous section. These make up the three sections of the cash flow statement, starting with cash flow from operations, followed by cash flow from investment, and ending with cash flow from financing.

If it seems like gathering financial information, calculating cash flow, and creating an accurate cash flow statement are challenging and time-consuming, it’s because they are—but not for businesses that turn to modern cash flow software solutions that offer powerful cash flow management functionalities and cash flow automation.

Software Solutions for Cash Flow and Cash Flow Forecasting

Cash flow software within a comprehensive ERP (Enterprise Resource Planning) solution offers businesses a single tool with cash management features to help users manage day-to-day transactions, track cash balances, handle funds transfers, and manage bank account reconciliations in one place—and do so in real-time.

With the right ERP solution, businesses can automate their cash flow management, streamline bank reconciliation processes, integrate with all financial modules (e.g., General Ledger, Accounts Payable, and Accounts Receivable), and accommodate tax requirements. An ERP solution’s customizable reports also help reconcile cash account balances, manage short-term cash reserves, and alert businesses to trouble.

ERP software further assists with cash flow forecasting by helping businesses predict future cash needs based on detailed transaction statistics,and, if the system is cloud-based, providing account security and integrity through access control to cash account information and balances.

Conclusion

To succeed in today’s turbulent economy, businesses must effectively manage their cash flow. Accurate and easy-to-create cash flow statements—along with income statements and balance sheets—will clearly show how much money is going into and out of your company, equipping you with the data you need to make wise financial decisions for today and for the future.

With Acumatica, businesses can rest assured that our cloud-based platform and seamlessly integrated Financial Management Suite and Cash Management System offer the features, reporting, and functionality to manage all of their cash flow needs. And their financial data—which resides in a single application—is available at any time and from anywhere.

Says Acumatica customer Ka Man Chan, Chief Financial Officer, Key Code Media, “Now we can see everything in Acumatica instantly. We can look at one unified ecosystem and understand where we are instantly. It’s wonderful.”

To learn more, contact our experts today.