If you are an entrepreneur, or even if you are thinking of starting your own business, it is extremely relevant that you master some basic indicators such as cash flowsince these are vital to keep your company afloat.
You do not need to be an expert in finance or accounting to operate a business, but it is important that you master some key concepts to avoid liquidity problems, project feasibility, or low profitability.
Undoubtedly, cash flow is one of the most important financial concepts, so you must master it perfectly so that you are able to successfully take charge of your company.
Understand what cash flow is
In this article we will explain in depth what is cash flowhow you can prepare it correctly, what are its types and what is the importance it plays at a business level.
The objective is for you to acquire the knowledge and tools necessary to keep your company’s finances fully up to date, which will allow you to expand it satisfactorily in the medium or long term.
Without a doubt, as soon as you understand what cash flow is, you will be ready to boost the liquidity and profitability of a successful company, and this will mean that it will be operating smoothly.
Additionally, you will be enriching your financial education, which is essential to wisely manage your money both at a personal and business level.
What is cash flow
This financial term is also known as liquidity flow, and refers to the flow of cash inflows and outflows -or cash- during a given period.
Within this financial report, income is recorded -from sales, rents, debt collection, loans or interest-, as well as money outflows -such as bill payments, taxes, salaries, basic services, debt repayments. , among others-.
It emphasizes that the difference between income and expenses is known as the balance or net flow. If this is positive, it implies that the income exceeded the expenses, and otherwise, the interpretation is that the expenses were greater than the income.
Understanding cash flow in depth
In financial terms, the liquidity flow refers to the net accumulation of liquid assets during a certain time, and consequently, it is a direct indicator of the liquidity of your company.
In this sense, you could clearly deduce that the less cash flow, the less liquidity, and this only reflects that your company is going through certain financial problems that you need to treat or solve before it is too late.
Cash flow types
There are three main types of cash flow, which we will outline in greater detail in the following lines:
Operating Cash Flow (FCO)
It refers to the money that comes in, or that you spend, depending on the activities that are directly related to your company.
Investing Cash Flow (FCI)
It has to do with the money brought in, or spent, that attends to a capital investment that will benefit your company in the future.
The purchase of new machines or equipment, real estate investments, and even acquisitions, are part of this type of liquidity flow.
Financial Cash Flow (FCF)
This is the money that comes in, or that you spend, depending on the main financial activities of your company.
For example: the receipt or payment of loans, the issuance or purchase of shares, or the payment of dividends.
Importance of cash flow for your company
If you don’t know what cash flow is, you will hardly be in tune with your company’s finances, and this is something that you simply cannot afford in your role as an entrepreneur or businessman.
Although at the beginning we told you that you do not need to be a professional in accounting, administration, or have a master’s degree in finance to carry out your project, it is mandatory that you understand how your company’s money flows.
Consequently, we will give you a few compelling reasons for you to master the importance that cash flow plays in the proper functioning of your company.
Allows you to identify liquidity problems
Liquidity is nothing more than the ability of your company to obtain cash in order to meet its financial obligations.
Some people have a wrong conception of this concept, and therefore, they tend to believe that not having liquidity is equivalent to not having a profitable business.
However, it is very possible for a business to be cash-strapped even when it is profitable, which is why anticipating cash balances is so important.
Helps you thoroughly analyze your projects
The cash flows represent the basis for calculating the net present value and the internal rate of return.
Both criteria are extremely relevant when analyzing the viability of an investment project, which will allow you to analyze more carefully whether or not it favors you to take the next step as an investor.
You can measure the profitability of a business
Cash flow allows you to measure the profitability or growth of a business correctly, accurately and responsibly.
In theory, you should do the numbers before investing money in a certain project, and a great way to take the first step is to formally understand this financial concept.
Helps you make better decisions
As such, analyzing the liquidity flow of your company will empower you to make good investment decisions.
Right now we will list some of the questions that you will be able to answer assertively when you know how to interpret this important financial report:
- Can you make cash purchases? Or do you need to apply for credit?
- Should you collect cash? Or could you grant some type of credit?
- Can the company pay its debts on time? Or is it necessary to request a refinancing?
- Are you able to invest the surplus money in new projects?
If you know how to analyze your company’s cash flow, you will be aware of the actions you must take to boost its profitability or liquidity successfully, and you will also be strengthening your financial intelligence.
How to prepare a cash flow
The starting point is to organize the information in a spreadsheet. Then you need to follow a few steps to make this financial report correctly.
In the next segments we will detail the most relevant elements that you must include in any cash flow report to reflect the net balance.
make a matrix
The best way to create or present a cash flow is by using a matrix. There you will have to work with columns and rows: in the first you will reflect the months (or a certain period of time), and in the second the income and expenses of money.
Remember that an inflow of money, or an income, is the cash that the company receives thanks to its productive or service activity.
On the other hand, an outflow of money, or an expense, is all that cash that is spent in relation to the production activity of your company (including fixed and variable costs).
Record financial information
Once you have defined the basic structure of this financial document in your spreadsheet, you must proceed to record the financial information that corresponds to each income or expense of the month.
For example, you must record the income from accounts receivable, or the expenses from accounts payable for the corresponding month, and repeat this process until completing each of the rows that you have created during the previous step.
Calculate the cash flow balance
When you finish registering the income and expenses in the corresponding months, all that remains is to calculate the cash flow balance.
It’s simple, all you have to do is subtract the total income from the total expenses and the difference is what is known as the balance, net flow, or cash flow balance.
Analyze the results
It will be useless to prepare a cash flow if you do not dedicate yourself to analyzing its results. That’s why the final step is to determine if your company’s cash is flowing positively or negatively.
Ideally, your company registers more income than cash outflows, or else it could face serious liquidity problems.
Example of a cash flow report
By way of illustration, we will share an example of a liquidity flow that will help you visualize and better understand what we tried to explain to you in the previous segment.
The reading of this financial document is clear: during the month of January the expenses were greater than the income, and consequently, the cash flow was negative.
However, during the following three months the difference between income and expenses was favorable, which produced a positive cash flow balance for the company.
Do you see it better now? Surely yes, and that is precisely the objective of developing a cash flow: to know how your own company’s money behaves and flows so that you can avoid debt or financial illiquidity.
Benefits of preparing a cash flow:
Now we would like to tell you about the main benefits of creating this document if you are the owner of a company, or if you are thinking of starting a project soon.
Gives way to new investments
Do you wonder how it is possible? The answer is quite simple: if you know how the money enters and leaves your company, you will be able to be aware of the positive balances that could have accumulated in some specific periods.
And this knowledge will allow you to identify other investment opportunities that will generate new sources of income for you.
Avoid financial setbacks
This document is crucial to anticipate potential cash shortfalls that could cause your company to face financial setbacks.
In this sense, you will be able to determine in time when it is necessary to request financing to get out, or so that your company can assume its financial commitments responsibly.
Reflects business growth capacity
A cash flow gives you a clear and detailed view of how your company’s money flows over time.
In simpler words: it allows you to see if you are earning more money over time, or if you are losing it.
And if in fact it is generating more income than expenses in a sustained manner, this can encourage you to expand your company since you will have noticed that it has a positive liquidity flow.
Start building your cash flow
Every businessman or entrepreneur must work on preparing a cash flow to know how much money his company earns and spends, since only then can he make the best business or financial decisions.
So if you are one of them, we invite you to follow the recommendations that we have just shared with you so that your financial report shows you if you are on the right path.
Continue reading: What is Factoring and how does this financing system work?