Managing Cash Flow 101

Welcome to the 40Billion.com startup guide for managing cash flow, designed for entrepreneurs and managers considering going into business for themselves. Cash flow is key to getting funding and keeping your business from failing. This startup guide provides information for managing and tracking the movement of cash into and out of your business. This includes a template for creating your own cash flow statement.

Ok, now the important part that our lawyers made us add: this overview is not meant to be a comprehensive guide for cash flow, and it is not intended to be legal advice in any way. We strongly encouraged you to consult a tax specialist, and the overview presented here is not meant to be tax advice.

So let's get started by defining the term Cash Flow. Simply put, cash flow refers to movement of cash into or out of any kind of business. It is usually measured for a certain time frame; daily, weekly, monthly or yearly.


Cash flow, sometimes referred to as Liquidity, is a very important concept for any business. In business, being profitable does not necessarily mean liquid. A business can fail because of cash or liquidity; meaning accounting wise (per books), a business may be profitable, but does not have liquid funds (cash) to pay for business expenses such as materials, payroll, etc.

Let's move forward and try to understand two components of cash flow: inflows and outflows. Inflows, as the term indicates, is the movement of money coming into the business, most likely from sale of goods. Conversely, Outflows are the movement of money out of your business, generally for purchase of retail inventory or cost of material in a manufacturing company, and paying for all other cash expenses such as utilities and payroll. Net Cash flow can be defined as cash inflows (receipts) minus cash outflows (expenses).

Let's move one step further and try to understand the Cash Flow Management concept. How can we effectively manage cash flow and avoid problems? In the real world, it is very difficult to match cash inflows and cash outflows. There is usually a lag between cash flows, if cash inflows are slower than outflows. For this reason managing cash flow is very important.

The first step would be to determine how much cash is needed to operate the business (expenses) and how much cash is generated by business (cash sales). The difference is called the cash flow gap, and you need to know how to manage the gap and continue business operations. The short term gap, usually negative, can be funded through a line of credit with the bank or other forms of borrowing such as a personal loan from friends and family.

The term Accounts Receivable is an important factor in understanding cash flow. Accounts Receivable represents sales that have not been collected as cash or sometime refereed as credit sales. Timely collection of accounts receivable is a very important part of cash flow analysis, because unpaid accounts receivable could impair your ability to pay your bills.

Let's move forward and use another tool that would help with cash flow, which is preparation of a Cash Flow Budget. Cash Flow Budget can be prepared using sales forecasts, normally using last year's sales numbers and adjusting those numbers for variables such as economy, competition, etc. as you move forward from month to month. In an all-cash operation, it's easy because all your cash sales will equal your cash flow budget. But in the real world, most of the businesses extend credit and become part of accounts receivable as we discussed before.

So how are we doing so far? Are you getting the hang of the concept? Let's review another concept which is very important for you as a business owner to understand. It is known as concept of Profit vs. Cash Flow. As we know, a simple definition of profit is sales price minus cost of goods sold. A general misconception is profit equals cash flow. This is true only when all sales are cash. But in the real world, goods are sold on credit with payments coming in incrementally. Accounting wise, in the Accrual Method of Accounting, when the sale transaction is closed, the whole amount of profit is booked as income. Cash-flow wise, it can take a month, two or longer to receive the entire sale amount, depending upon terms of the credit sale. Based on the above, we can safely conclude that for business owners, it is very important to understand the difference between profit and cash flow.

Now let's understand the important components that would help us in analyzing cash flow:

Accounts Receivable: Earlier we defined Accounts Receivable as the portion of sale that has not been collected as cash. This is the amount the purchaser owe seller and has agreed to pay over the period of time. Timely collection of accounts receivable is very important in managing (analyzing) cash flow and trying to narrow the cash flow gap.

Terms of Credit: As we noted earlier, in real world all sales are not cash and especially here in United States which is known as Credit Society, bulk of the sales are on credit, meaning purchaser will pay the amount over agreed period of time. More generous credit terms (longer time to pay) could affect cash flow significantly. To alleviate this situation, some seller would offer a cash discount to entice the purchaser to pay the entire amount at the time of sale.

Inventory: Inventory is the supply of merchandise also known as stock to meet the demands of customer. If inventory controls are not in place, it could tie up significant amount of cash in non income producing asset. The merchandise that sits on the shelf cost money to the business owner. An efficient system of procurement of merchandise from the wholesaler can also help in improving cash flow.

Accounts Payable: Accounts Payable is opposite of Accounts Receivable as we noted before. Accounts Payable is the amount you owe to the supplier. This amount is paid to the supplier over the period of time as agreed. Timing or terms of accounts receivable and accounts payable is important in maintaining a healthy cash flow position.

We have tried to cover all major aspects of cash flow management. Your accountant may provide you with additional help depending up on your business needs. He/she may also provide you with additional tools such as use of spreadsheets to make process lot easier.

In conclusion, for business owners, cash flow budgeting and cash flow statements are very important in seeking financing for major purchases or expansion. The lender will take a look at your cash flow statement to determine whether your business is generating enough cash to cover loan payment for duration of loan.


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