How Does Cash Flow Work?

5 min read

Executive Summary

If there is one thing that any business owner needs to know, it is its business’s cash flow. Understanding your company’s cash flow can help you maintain a healthy business and give you a competitive edge. It is crucial to know how much cash the business has on hand, how much cash is received and spent over time, and how much cash is sufficient to manage its operations and fund future growth. One way to do this is to stay on top of your company’s cash flow statement.

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What is cash flow?

Your cash flow is the net amount of money moving in and out of your business over a given period of time. Cash flow is recorded in statements that are usually released either on a monthly or quarterly basis. These cash flow statements are one of three accounting tools crucial to understanding your business, the other two being your income statement and your balance sheet. That being said, the cash flow statement differs from the other two in that it specifically tracks the value of liquid assets available to you.

In this article, we are going to cover how cash flow statements differ from other financial statements, how to build a cash flow statement, how to calculate your burn rate and runway, how to forecast cash flows, and ways to stay on top of your cash flow.

Why does it matter?

Keeping track of your cash flow is extremely important because simply put, cash is the fuel that runs your business. The first step to establishing a healthy cash flow for a newly established business would be to “break-even,” or accumulate the same amount of cash used to cover the initial capital invested in the business. Excess cash can then be used to pay off increasing expenses and debts, converted into other assets, or reinvested into your business as improved equipment or a wider product inventory. Keeping a healthy, positive cash flow is thus crucial to keeping your business alive.

Breaking down a cash flow statement

There are two methods for building a cash flow statement. Each has its advantages and disadvantages, and one may be more suitable to your situation than the other.

The direct method entails listing out all of your cash income and expenses over a given period of time. The advantages of this method include a more detailed breakdown of cash flow over different divisions of a business, making it attractive for larger businesses seeking to optimize. However, this method requires a meticulous review of income statements and balance sheets, making it more time consuming and unnecessarily complex for smaller businesses.

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The indirect method is much simpler, starting out with your net income over a given period of time and adjusting it for inflows and outflows. As a small business owner, this method may be more convenient for you.

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Burn rate and runway

Another metric to pay attention to that is not included in your cash flow statement, but can be extrapolated easily from, is your burn rate. Your burn rate is the collective amount of money you spend on expenses over a given period of time and is measured in dollars per month or quarter.

Once you have figured out your burn rate, you can start calculating your cash runway. This is defined as the length of time your business can operate on your current cash reserves in a zero income situation, given that expenses stay constant. A longer runway translates to a better chance of surviving crisis situations, pandemics, and market downturns. Six months is a good starting length for your runway, as it provides an ample buffer for you to pivot or draw on a credit line should you need to.

Calculating these two metrics is crucial to understanding the health of your business, as they will give you an idea of how long you can sustain operations should things head south.

What are the differences between cash flow, profitability, and revenue?

Profit, revenue, and cash flow are three distinct accounting metrics. Each serves its own purpose in measuring the performance of your business. Consider a scenario where you have signed off a six-figure contract but have yet to receive payment. In this scenario, your business may be profitable, but it does not have a sufficient operating cash flow (OCF). No matter how many contracts you have signed, you may not have enough money to pay your bills without sufficient cash flow.

Positive or negative cash flow simply means you either have more or less money on your balance sheet than you had at the beginning of a given period of time. While it is dependent on the stage and the industry you are in, targeting to have positive cash flow sustainably can help you weather any surprises in your business and you outlast your competitors.

Securing and maintaining positive cash flow

The basic principle to keep in mind here is to keep overhead costs low while searching for ways to increase your revenue.

There are four options to increase your revenue, these being:

  1. Attracting more customers
  2. Increasing your average sales volume
  3. Increasing sales frequency
  4. Raising prices

Likewise, your ability to reduce overhead hinges on reducing your cost of goods sold (COGS) and lowering your operating expenses such as payroll, rent, utilities, and other services.

Further, you can also look at improving your cash conversion cycle. You can speed up your invoice cycle by shortening your receivable payment terms, offering more payment options, or incentivizing your customers to pay earlier with discounts. Conversely, you can renegotiate with your vendors to extend your payment terms. If you have inventory, your goal is to increase your inventory turnover to improve your cash conversion cycle which will increase your operating cash flow.

Now that you know what cash flow is, why it is important for your business, and how to maintain positive cash flow, you are ready to execute. Staying cash flow positive is a gradual process that requires consistent work even after you break even, but it is definitely possible with time and effort.

About the author

Kathryn Rungrueng

Written by Kathryn Rungrueng

The Tillful team is writing articles to help companies grow their credit and improve their business financial health. If there’s a topic you’d be interested in learning about, let us know at

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