Why Cash Flow Is Important for Your Small Businesses

Without a steady influx of cash, your business can't stay on its feet. Learn why cash flow is as important as profit—if not more so—and how to successfully track your business's cash inflow and outflow with the all-important cash flow statement.

Want to instantly gauge a business’s financial health? Check out its cash flow. If there’s a steady stream of incoming cash, excellent—you’re on the road to small-business success. If not, buckle up: you’re in for a bumpy ride.

Okay, measuring a business’s health isn’t quite as simple as checking cash flow alone. Profit, loss, equity, and, of course, a solid idea and ready audience all play a part in how long a business lasts. But cash flow, or the movement of cash into and out of a business, nabs the starring role in a business’s success (or failure) every time. After all, without a constant influx of cash, no business can stay afloat, no matter how solid its starting idea or willing its market.

Want more info on how cash flow can make or break your business? Keep reading—we explain cash flow’s definition, where cash comes from, and the importance of the cash flow statement in maintaining a healthy business.

What cash flow means for small businesses

If your business is a body, cash is the oxygen: when cash moves in and out of your company at a healthy rate, your business is alive and kicking.

Obviously (and here’s where our metaphor breaks down), businesses prefer more cash flowing in than out. When you have positive cash flow, you’re making enough money to cover your bills and even reinvest in your business, expanding operations and hiring new employees. When you have negative cash flow, you aren’t making enough money to cover the cost of your operations. Your business, friend, is on its way out, unless you can manage your cash flow and figure out how to make more than you’re spending.

Types of cash flow

There are three main areas where cash can flow into or out of your business: operating activities, investing activities, and financing activities.

Cash flow from operating activities (CFO)

Cash flow from operating activities refers to cash flow from everyday business operations, such as the following:

  • Sales of goods or services
  • Employee wages
  • Supplier payments
  • Income tax payments

For example, imagine you own a small bakery. Every donut you sell and catering contract you sign represents cash flowing into your business from operating activities. In contrast, paying the company that supplies your flour represents cash flowing out of your business.

That outward flow isn’t a bad thing. It might sound cliché at best and nonsensical at worst, but you really do need to spend money to make money, and hiring employees and paying suppliers is crucial for your business to run smoothly. You just need to counterbalance that output with a steady influx of cash, hopefully from both operating activities and the two other types of cash flow.

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Cash flow from investing activities (CFI)

Cash flow from investing activities means cash flow to and from long-term investments. This could mean literal stock investments, but for many small-business owners, it’s more likely to mean an investment in a piece of heavy equipment (like an industrial fridge) or property for your expanding bakery franchise.

Cash flow from investing activities can include capital expenditures, or CapEx. Capital expenditures refer to the cash you invest in physical, fixed assets, like upgrading the electrical system in a warehouse you already own. Even though you’re putting money into a project, the expense isn’t necessarily a liability—it’s an investment in your future that you expect to yield dividends.

In contrast, operating expenses, or OpEx, represent short-term payments that keep your business on its feet day to day. OpEx are listed under cash flow from operating activities, not investing activities.

Cash flow from financing activities (CFF)

Cash flow from financing activities refers to money you spend and gain on funding your business. In other words, it’s the money that flows between your business and the people and entities who invested in it, like banks or shareholders. Debt payments, stock issuance, and dividend payments to shareholders are some of the key components of cash flow from financing activities.

Cash flow statements

So how do you track how much cash you have and where it’s going? With the (very logically named) cash flow statement. Cash flow statements list your sources of cash, breaking them down by the type of cash activity (operating, investing, or financing activity) and the transaction date.

Why cash flow statements matter

Along with income statements and balance sheets, cash flow statements are the most important financial documents for small-business owners. Why? For one, they’re necessary if you use accrual-basis accounting, which tracks income as you earn it instead of as you receive it (ah, the joys of tracking down customers with overdue invoices).

Not every business needs to use accrual-basis accounting. Instead, some use cash-basis accounting, which more directly tracks cash instead of profits. But if you sell inventory, the IRS requires you to use accrual rather than cash accounting. And without the statement of cash flows to compare to your income statement, you won’t always know exactly how much money is sitting in your account at a given moment.

Accrual-basis accounting

If your business uses accrual-basis accounting instead of cash-basis, you’ll need to frequently compare the profit on your income statement to the actual cash inflow and outflow on your statement of cash flows. Otherwise, if you list a payment when you finish a project but don’t get paid immediately, you might accidentally spend money you don’t have.

For another, cash flow statements are one of the key documents investors look at when deciding to finance your business or not. Put alongside the profit and loss (income) statement and balance sheet, the cash flow statement reveals the state of your business, which in turn helps investors decide if they trust you with their money.

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Types of cash flow statements

Cash flow statements come in two flavors: direct and indirect.

Direct cash flow statements don’t include your business’s non-cash assets in the cash flow from operating activities section—it quite literally measures only physical cash transactions.

Indirect cash flow statements are much more common. This method includes non-cash assets and liabilities in its operating activities tally (think accounts payable, accounts receivable, and asset depreciation). In other words, it shows how much you’re making and spending, not just how much cash literally moved from a customer’s wallet into yours. (Psst: if you use accrual-basis accounting, the IRS requires you to draw up indirect cash flow statements only.)

Formatting-wise, indirect cash flow statements start by listing your net income at the top of the sheet. Direct cash flow statements don’t list net income and instead simply list each cash transaction in order by date.

How to create cash flow statements

If you need a cash flow statement to check your business’s cash flow or draw investors, you have three main options for drawing one up:

  • Accounting staff (bookkeepers, accountants, or CPAs)
  • Accounting and bookkeeping software
  • Spreadsheet programs

An in-house, outsourced, or on-call accountant can spit out a cash flow statement in a flash. Accountants, who focus more on analyzing financial data than bookkeepers do, can also walk you through each facet of your cash flow statement, explaining where to save and where to spend to keep your business booming.

No accountant? No worries. Generate a cash flow statement yourself using accounting software like QuickBooks or Xero. Don’t want a cloud-based accounting software subscription? You can use spreadsheet programs like Microsoft Excel or Google Sheets to create your own statement. Microsoft offers some templates, but you should expect to spend more time entering data and triple-checking your work than you would with an accountant or software.

Cash flow FAQ

Why is operating cash flow important?

Operating cash flow, or OCF, is the money your company earns via daily business activities. To stay financially solvent, you must make enough money through general operating activities to cover your daily operating expenses. Otherwise, your business can’t sustain itself and, unfortunately, will likely fail.

Operating cash flow is particularly important for investors, who often look at both OCF and net income when deciding to invest or not. While net income shows if the company is keeping its head above water for now, its operating cash flow shows if it’s actually making money—and few investors want to put their money down on a business that doesn’t generate cash.

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How do small businesses maintain cash flow?

Small businesses typically generate cash flow through the sale of goods and services. Since cash flow isn’t always consistent throughout the year, especially for seasonal businesses like lawn and gardening companies, small businesses also maintain cash flow via financing and investing activities. Issuing stock, taking out small-business loans, and cutting costs also help small businesses maintain cash flow throughout the year.

What is cash flow in a small business?

Cash flow is how much money moves in and out of your business at a given moment in time. It measures how much liquid cash you have on hand and indicates if your business is financially solvent or not. Small businesses get cash through investors, loans, and sales of goods or services. Cash leaves the business through bill payments, worker salaries, and other expenses.

The takeaway

In the small-business world, cash really is king. An overall positive cash flow indicates that your business is primed for success—so keep those cash influxes coming. If you don’t have positive cash flow yet, throw together a cash flow statement to see where you can cut back and how to bring your business back in the black.

Want help from an accountant who can draw up and analyze a new statement of cash flows? Scan our favorite virtual and outsourced accounting services for small businesses.

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