As a business owner or manager, it’s essential to understand the concept of cash flow. Cash flow is the movement of money in and out of your business and is critical for your business's survival and growth. 82% of all businesses fail due to poor cash flow management or poor understanding of cash flow itself. [1] In this article, we’ll explain what cash flow statements are, why they’re important in business planning, how to create a cash flow statement and how to analyze it, common cash flow problems and solutions, and cash flow forecasting and budgeting.

Understanding Cash Flow in Business

Cash flow is the lifeblood of any business. It’s the money that comes in and goes out of your business, and it’s crucial to keep it running smoothly. There are two types of cash flow: positive cash flow and negative cash flow.

Positive cash flow occurs when the money coming into your business is greater than the money going out. This means you have enough money to cover your expenses, pay your employees, and invest in your business's growth. Negative cash flow occurs when the money going out of your business is greater than the money coming in. This means you may not have enough money to cover your expenses, pay your employees, or invest in your business's growth.

What are Cash Flow Statements?

Cash flow statements are financial documents that show the movement of money in and out of your business over a specific period. They show how much money came in, how much money went out, and the difference between the two. 38% of small businesses fail because they run out of cash, and only 45% of small business owners monitor their cash flow. [2] Cash flow statements help in understanding your business's financial health and making informed decisions about its future.

Cash flow statements are divided into three sections: operating activities, investing activities, and financing activities:

Operating activities show the money coming in and going out of your business's day-to-day operations, such as sales and expenses.

Investing activities show the money coming in and going out of your business's investments, such as buying or selling assets.

Financing activities show the money coming in and going out of your business's financing activities, such as taking out a loan or paying dividends to shareholders.

Why are Cash Flow Statements Important in Business Planning?

Cash flow statements provide insight into your business's financial health. They show how much money is coming in and going out of your business, and they help you understand your business's cash flow patterns. By analyzing your cash flow statement, you can identify areas where you may need to increase revenue or decrease expenses. You can also use your cash flow statement to make informed decisions about investing in your business's growth or paying off debt.

Cash flow statements are necessary for securing financing or investment for your business. Investors and lenders want to see that your business has positive cash flow and is financially healthy. By providing a cash flow statement, you can demonstrate your business's financial stability and potential for growth.

How to Create a Cash Flow Statement

Creating a cash flow statement is relatively straightforward. You can create one using a spreadsheet program like Microsoft Excel or Google Sheets. Here are the steps to create a cash flow statement:

1. Identify the period you want to create the cash flow statement for, such as a month or a quarter.
2. Gather your business's financial documents, such as income statements and balance sheets, for the period you want to create the cash flow statement for.
3. Create three sections for your cash flow statement: operating activities, investing activities, and financing activities.
4. Enter the money coming in and going out of your business for each section.
5. Calculate the net cash flow for each section by subtracting the money going out from the money coming in.
6. Calculate the total net cash flow by adding the net cash flow for each section.
7. Analyze the cash flow statement to identify areas where you may need to increase revenue or decrease expenses.

Analyzing Your Cash Flow Statement

Here are some things to look for when analyzing your cash flow statement:

Positive or negative cash flow: Positive cash flow means you have enough money to cover your expenses and invest in your business's growth. Negative cash flow means you may not have enough money to cover your expenses, pay your employees, or invest in growing your business.

Cash flow patterns: Look for patterns in your cash flow statement. Are there times when your business has more cash coming in or going out? Understanding your cash flow patterns can help you make informed decisions about the future.

Cash flow ratios: Calculate your business's cash flow ratios, such as the operating cash flow ratio and the free cash flow ratio. These ratios can help you determine your business's liquidity and financial health.

Common Cash Flow Problems

Many businesses experience cash flow problems at some point. Here are some common cash flow problems and solutions:

Slow-paying customers: If your customers are slow to pay their invoices, it can put a strain on your cash flow. Consider offering incentives for early payment, such as a discount or free shipping. Nearly one-third (31%) of small business owners say they wait more than 30 days for payments. [3]

Seasonal fluctuations: If your business is seasonal, you may experience fluctuations in cash flow throughout the year. Consider setting aside money during your busy season to cover expenses during slower periods.

Overhead expenses: If your overhead expenses are too high, it can eat into your cash flow. Consider reducing your expenses by renegotiating contracts or finding more cost-effective solutions.

Cash Flow Forecasting and Budgeting

Cash flow forecasting involves predicting how much money will come in and go out of your business over a specific period. Cash flow budgeting involves creating a plan for how you will allocate your business's cash flow.

Here are some tips for cash flow forecasting and budgeting:

Use historical data to make predictions: Look at your past cash flow statements to make predictions about your future cash flow.

Plan for contingencies: Account for unexpected expenses or changes in revenue when creating your cash flow forecast and budget.

Monitor your cash flow regularly: Regularly monitoring your cash flow can help you identify issues early and take action to address them.

Cash flow statements are important for business planning and financial management. They provide insight into your business's financial health and help you make informed decisions about its future. By creating and analyzing your cash flow statement, you can identify areas for improvement and make changes to increase your business's profitability. Cash flow forecasting and budgeting are also critical for managing your business's cash flow and ensuring its long-term success.