What Is Cash Flow?

Cash flow is a description of how and when cash (and cash equivalents) flow in and out of a business.

Having a positive cash flow means more money is coming in than going out of your business. However, having a negative cash flow means more money is going out than coming in.

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What Is a Cashflow Statement?

The cash flow statement is a financial statement that shows when and where cash flows within your company.

It describes how cash flows in and out of your company from operating, investing, and financing activities and shows how much cash you can expect to have on hand at any single point in time. The cash flow statement is one of the three key financial statements that depict the overall financial health and projections of your company.

Types of Cash Flow

The three main types of cash flow are cash from operating activities, cash from investing activities, and cash from financing activities.

Cash from operating activities is the flow of any cash in or out of the business from the business’s normal activities and operations. This includes any revenue from the sale of goods or services as well as any expenses related to operating your business, such as salaries and wages, rent, utilities, supplies, raw materials, and any other operating expenses.

Cash from investing activities is the flow of any cash in or out of the business related to the business's assets and investments. Cash from investing includes the purchase or sale of physical assets and the investment in or sale of securities.

Cash from financing activities is the flow of any cash in or out of the business related to investors, banks, and shareholders. Cash flowing in from financing includes the proceeds of any loans or the issuance of any shares or bonds. Cash flowing out from financing includes the repayment of the principal of any debt as well as the payment of dividends to shareholders or the repurchase of any stock.

Why Is Cash Flow Important?

Cash flow is the lifeblood of your business. You need cash (or cash equivalents) to pay for materials and supplies, wages, rent, utilities, and other expenses.

Run out of cash to pay your bills, and you will likely soon be out of business. Thus, it is important to understand when and where money is coming in and out of your company.

Understanding your company’s cash flow will help you manage your company’s finances so that you have cash on hand when you need it. You will know exactly how much cash you will have at any given moment.

Cash flow is especially important when starting a business. Until you attain customers and achieve enough sales to at least break even, more cash will be going out of your business than is coming in. Hence, you may need to rely on personal funds, loans, credit cards, and lines of credit to carry you through this time. However, under projecting expenses or over projecting sales can leave you with a cash crisis.

Cash flow is also particularly important for seasonal businesses. In a seasonal business, the majority of income is earned during a peak season. However, there are likely to be fixed expenses that need to be paid throughout the entire year. Managing your cash flow in a seasonal business presents challenges but is possible when you understand where and when cash flows in and out of your business.

Understanding the Cash Flow Statement

The cash flow statement describes how cash (and cash equivalents) flow in and out of your company from operating, investing, and financing activities. It is one of the three key financial statements that depict the overall financial health and projections of your company, telling you how much cash you expect to have on hand at any single point in time.

Cash flow statements are prepared using either the direct or the indirect method. The direct method is based on cash accounting and records inflows and outflows as they occur. The indirect method is based on accrual accounting (which is the method of accounting that most companies use) and begins with the net income from the income statement.

Cash flow statements are organized by periods. These may be monthly, quarterly, or annually. Cash flow statements are typically prepared monthly for the first year, quarterly for the second, and annually for the third year and beyond.

The cash flow statement is laid out in five sections:

  1. Beginning Cash and Cash Equivalents
  2. Cash from Operating Activities
  3. Cash from Investing Activities
  4. Cash from Financing Activities
  5. Ending Cash Balance

Beginning Cash and Cash Equivalents

Beginning cash and cash equivalents is the cash you have on hand at the beginning of a period.

For a startup, the beginning cash on hand in the first period would be $0, and any loans, lines of credit, or equity contributed by the owners would be accounted for in the first period. For every other period, your beginning cash on hand would equal the ending cash balance from the previous period.

  Jan Feb Mar Apr May Jun
Beginning Cash and Cash Equivalents $0 $37,500 $32,500 $30,000 $27,500 $25,000

Cash From Operating Activities

The second section of the cash flow statement is cash flow from operations. This is the cash flowing in and out of the business through normal operations.

The cash from operating activities begins with your net income from the sale of products or services.

However, for your actual cash flow, you need to adjust for non-cash expenses (i.e. depreciation and amortization expenses) as well as any changes in working capital (adjustments to inventory, prepaid or accrued expenses, accounts payable, and accounts receivable). These are all items that are reflected in net income but did not affect your cash flow within that period.

  2022 2023
Beginning Cash and Cash Equivalents $12,500. $42,250
Cash Flow From Operations
Net Income + $60,000. $75,000.
Adjustments for Noncash Expenses      
Depreciation + $5,000. $5,000.
Amortization + $1,500. $1,500.
Change in Working Capital      
Inventory - $2,500. $3,000.
Prepaid Expenses - $1,000. $500.
Accrued Expenses + $500. $0.
Accounts Receivable - $3,000. $5,500.
Accounts Payable + $750. $500.
Net Cash From Operations   $61,250. $73,000.

Cash From Investing Activities

The third section of the cash flow statement is cash flow from investing. This is the cash flowing in and out of the business through activities that are treated as investments such as land, buildings, vehicles, machinery, and equipment.

  2022 2023
Net Cash From Operations $61,250. $83,000.
Cash Flow From Investing
Purchase of Equipment - $16,000. $12,000.
Improvements and Renovations - $7,500. $5,000.
Sale of Equipment + $1,500. $2,500.
Net Cash From Investing   ($22,000) ($14,500)

Cash From Financing Activities

The fourth section of the cash flow statement is cash flow from financing. This is the cash flowing in and out of the business through activities that are related to the financing of a business. This includes accounting for the owners’ or shareholders’ contribution to the equity of the company as well as the proceeds from and repayment of the principal of any loans or lines of credit.

  2022 2023
Net Cash from Investing ($22,000) ($14,500)
Cash Flow From Financing
Proceeds From Line of Credit + $2,500. $0.
Repayment of Line of Credit - $0. $2,500.
Repayment of Loan Principal - $12,000. $20,000.
Net Cash From Financing   ($9,500) ($22,500)

Ending Cash Balance

The ending cash balance is the final section of the cash flow statement. The ending cash balance summarizes the net cash from operations, investing, and financing and reflects the amount of cash left on hand at the end of the period. The ending cash balance accounts for the beginning cash on hand plus or minus net cash from operations, investing, and financing.

The ending cash on hand will be equal to the beginning cash on hand for the next period.

Beginning Cash and Cash Equivalents $12,500. $42,250
Net Cash From Operations +/- $61,250. $73,000.
Net Cash From Investing +/- ($22,000) ($14,500)
Net Cash From Financing +/- ($9,500) ($22,500)
Ending Cash and Cash Equivalents $42,250 $78,250.

Cash Flow Formulas and Ratios

You also need to understand how cash flow is calculated. There are several cash flow formulas depending on what you hope to learn from the cash flow statement.

Here are the key cash flow formulas and ratios:

Total Cash Flow

Cash From Operating Activities +/- Cash From Investing Activities +/- Cash From Financing Activities

Free Cash Flow

Net Income + Non-Cash Expenses (Depreciation/Amortization) - Taxes +/- Change in Working Capital - Investments in Operating Assets

Operating Cash Flow

Net Operating Income + Non-Cash Expenses (Depreciation/Amortization) +/- Change in Working Capital

Cash Flow Forecast

Beginning Cash (and Equivalents) + Projected Inflows - Projected Outflows = Ending Cash

Cashflow Statement Frequently Asked Questions

What is the difference between cash flow and income?

Income refers to a company’s profit — its revenues and expenses. Income is reflected on the income statement (also called the profit and loss statement) and is closely connected to cash flow. However, your company’s net income also includes noncash expenses and investments in the future of the company such as the purchase of major assets.

Cash flow reflects the exact inflows and outflows of cash across a period of time. The cash flow statement adjusts for noncash expenses and changes in working capital, providing a better picture of your company’s resources across a period of time.

What is an example of cash flow?

Cash flow accounts for every incoming and outgoing payment of cash or cash equivalents. The most common cash flow items are related to operations (sales revenue, accounts receivable, rent expenses, utilities, wages and salary, materials, services, and supplies), to investing (the purchase or sale of major assets), and financing (the proceeds or repayment of any loans or lines of credit, the distributions of dividends, sale or stock, or contributions or distributions from owner’s equity).

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