Contrary to popular belief, the amount of money that comes into a business does not determine it’s financial security or success. That’s why it is important that business owners understand the concept of cash flow.
Cash flow refers to the amount of cash and cash equivalents that enter and leave a business. Essentially, it is the total money coming in to a business minus the total money going out of a business.
Cash Flow measures how well a business manages its earnings. It demonstrates how a business manages expenses, pays debt obligations, and funds resources. A company can utilize a cash flow statement to help with matters of budgeting and better predict whether a company has enough cash to cover its current and future expenses.
Cash Flow can simply be broken down into two categories:
Positive Cash Flow
If a business has a positive cash flow, it is generating more than it is spending. For example, let’s say company Bob’s Donuts made 600,000 dollars in 2020 but spent 400,000. These numbers indicate a positive cash flow, meaning that Bob’s Donuts will be able to use those funds to reinvest back into the business, by either acquiring new equipment, stronger marketing, or even storing away funds as preparation for unforeseen obstacles that may likely arise in the future. Positive Cash Flow is a primary indicator of a business’s longevity.
2. Negative Cash Flow
If a business has a negative cash flow, it is spending more than it is generating.
For example, if Rob’s Donuts made 400,000 this year but spent 600,000 it is operating cash flow negative. Having a negative cash flow can result in debt accumulation and may have serious consequences for a business. Often times, Negative Cash Flow is the primary reason why businesses close shop.
Understanding cash flow is a helpful way to measure of a business’s strength and longevity.