Demystifying Cash Flow Management Terms: A Comprehensive Guide

At its core, profitable business management comes down to being more proactive and less reactive in managing the cash flowing through your business.  Knowing your sources of cash is key to projecting when that cash is coming in.  Following the flow of money through your business tells you when and where cash will be needed to fund operations.  Knowing this is the only effective way to disburse your money wisely.

Cash management starts by knowing what your sources and uses of cash are for your business.

The following table outlines the most common sources and uses of money in every business of any size:

Cash Inflows = Sources of Money	Cash Outflows = Uses of Money
Cash inflows represent any source of funds that come into the business: ·         Cash Sales ·         Sales Deposits ·         Customer Account Sales (A/R) ·         Line of Credit Advances ·         Loans from Lenders ·         Outside Investment Money ·         Personal Savings ·         Interest Earned on Savings ·         Repayment of Employee Loans ·         Other Money Receipts	Cash outflows are uses of funds by the business: ·         Payroll + Payroll Taxes ·         Sales + Other Taxes ·         Recurring Expenses ·         Vendor/Supplier Payments ·         Rent or Mortgage Payments ·         Lease Payments ·         Interest Expenses ·         Credit Line Repayment ·         Long-term Notes Payable ·         Miscellaneous Charges

What is the difference between cash flow and cash management?

No matter what the amount of cash flowing through your business is, you’ll face both internal and external problems outside of your control that will hinder timely cash flow.  If unresolved, these obstacles can result in serious financial difficulties, particularly when a business owner fails to understand the differences between the following cash terms of cash flow and cash management.

Cash Flow represents how the business receives cash, processes it through its accounting system, and disperses it to those owed money.

Cash Management represents the proactive control over cash receipts dispersed through disciplined control over cash outflows based on accurate cash inflow projections.

What are other critical business cash flow terms I should know?

Cash Assets represent ready money you have, such as money in hand, petty cash, bank account balance, customer checks, marketable securities, and the unutilized portion of a line of credit.

Accounts Receivable consists of sales made, but not yet paid for by the customers (trade debtors). This number represents the amount of money still owed to a business by its customers after receiving the goods or services they purchased.

Accounts Payable represents the amount of money a business owes its creditors (suppliers, etc.) in return for the goods and services they have received but not paid for.

Business Cash Flow represents the cash flowing in from the sales, finance, and investor activities of a business and out of its operating activities.

Operating Cash Flow represents the difference in the amount of opening cash available at the beginning of a period and the amount at the closing or end of the period of business operations.

Cash Flow Ratio measures how adequate available cash balances are to pay off all of a business’s current debts.  It is calculated by adding cash and cash equivalents together divided by current liabilities.

Cash Flow Analysis is the detailed examination of cash flowing in and out of a business during a specific period of time.  The analysis determines what drove the changes in cash from the beginning balance to the ending balance for that period, starting with the study of cash receipts followed by the analysis of paid expenses to determine what went well in the business and where money was lost.

Cash Flow Forecast predicts or estimates a future cash position in terms of timing and amount.  It starts with cash inflows for a week, month, or year followed by the planned cash outflows during the same forecasted period.  The results of the cash flow projection are used to fine-tune business activities based on the anticipated amount of money available during the forecasted period.

Cash Flow vs. Gross Sales represents the potential in every dollar of gross sales made to be a whole dollar of cash when collected that you can use to pay expenses.  The amount of cash collected from gross revenue after paying ALL expenses represents your profit.  There is no cash flow from a gross sale until the customer payment is collected.

Cash Flow vs. Revenue is a more accurate representation of the potential in every dollar sales made to be a total cash dollar when collected to pay expenses.  The difference between gross and net sales is the deduction of sales discounts, returned merchandise credits, and write-offs for a bad debt from Gross Sales.  It does not represent cash flow until the money made from a sale is collected.

Cash Flow vs. Net Profit represents two very different numbers.  Cash flow can include cash from operations, investment money, and borrowed money.  Net Profit or Net Income is the bottom line of the P&L Statement after all expenses are deducted from net revenues earned during an accounting period.

Cash Flow vs. Free Cash Flow represents the cash balance after deducting tax and capital expenditures from operating earnings before interest, tax, depreciation, and amortization (EBITDA) instead of cash flows in and out from operating activities.

Cash Flow Funding identifies the source of money used in a business to fund its operations and asset purchases.  Primary cash flow for any business is sources of money collected from operations, investments, and financing activities through leases, loans, or a line of credit.

Financed Cash Flow represents money acquired from financial institutions in exchange for principal and interest payments to fund capital expenditures in a business.  These money sources are primarily used to acquire assets and pay financial obligations when available cash is less than cash-out requirements.

Net Cash Flow is the amount of cash remaining after subtracting ending cash outflows for a period from the beginning cash balance plus cash inflows collected during that period.

Negative Cash Flow occurs any time the ending cash balance is higher than the opening cash balance.  When this happens, you are spending more cash than you are taking in.

The key to being a great business manager is proactively managing your sources and uses of money at a profit.  You know you are doing this when you aren’t worried about cash outflows exceeding cash inflows.

Understand that the amount of cash flowing through your business does not mean you are a great business manager.  Nor does high cash flow levels mean you are likely to earn a profit, nor do high levels of profit automatically translate into positive cash flow.

Three more key cash terms to understand about business cash flow:

• Why do I always want to have a goal for improving my cash flow from operations?
• When should a business owner take on investors?
• When should I borrow money?

Why do I always want to have a goal for improving my cash flow from operations?

Cash is not profits, and profits are not cash.  Those who don’t accept this difference fail to grasp that the best cash flowing into your business is your cash flow from operations.  You are a successful business when you own a business that is self-funding your business growth from your operating cash flow.  Setting a goal around how you can do this is always a smart goal that will never grow old.

The amount of your cash flow from operations is a direct function of the quality and velocity of the cash coming into your business.  Again, the quality of cash is a function of your gross profit and operating income.  Cash quality represents the amount you have left in the bank from your sales after paying your COGS, SG&A, and other non-operating expenses.  In the long term, your business needs to be about continuously improving your cash quality.

When should a business owner take on investors?

The primary reason a small business owner takes on an investor is to gain access to their money to fund their business growth operations because they don’t have enough of their own.  The tradeoff is they give up sole control of their business proportionate to the amount of money they took from the investor.

When you take on an investor, you must earn more money from operations because of their investment than you could without it.  No investor will give you their money without some expectation of return for the money they put at risk with you.

You also want to ensure that their personality, financial return expectations, and time frame for earning their return align with your personality and vision.  Failure to be aligned will result in you either buying them out at a premium or the investor pushing you out of your business because they will never accept you’re losing their money.

When should I borrow money?

You borrow money for two primary reasons.  The best reason is when you don’t want to tie up the majority of your cash in the purchase of an asset, so you take out a loan or lease to finance your fixed asset purchase over time.  You do this because you believe the new asset you acquire will increase your capacity to generate higher sales and profits.

The biggest challenge with financing the acquisition of fixed assets occurs when the profit generated from the financed asset fails to cover the monthly principal and interest payments for that asset.

The worst reason to borrow money is to cover cash shortfalls.  Yes, a line of credit is a great way to cover you during the lows in your cash flow cycle.  The downside of any line of credit is when you fail to meet your line of credit obligations, and it gets converted to a loan.  Either way borrowing money to meet payroll, pay taxes, or pay a creditor is cause for alarm.  It means your business is out of control.

Business owners who take out high-interest loans from predatory lenders are those who struggle to collect payment for their products and services when due.  They are highly likely to have ZERO cash quality and, as a result, have NO cash velocity.  They only have cash outflows draining the life out of them and their business.  Don’t let this happen to you.

What does your profit-to-cash correlation tell you about your business?

Click here to have a BusinessCPR™ Business Scientist tell you about the patterns and trends in your business that you can take action to build on where your profits are driving higher cash reserves and where fixes are needed.  Ultimately, any failure to fix profit leaking from your business is a failure to manage your cash.