Cash flow provides a better understanding of a firm’s liquidity, flexibility, and overall financial health. Business activities generally involve cash inflow via income from sales revenues and cash outflow via fixed and variable expenses. For a business to be cash flow positive, its cash inflow should exceed the cash outflow. Positive cash flow is essential for any business to survive, prosper, and sustain long-term growth.
Cash flow positive: What is it?
Cash flow positive simply means more cash coming in than going out. This metric indicates that a business has enough working capital to cover all its bills and will not need additional funding.
Additionally, a consistently positive cash flow infers that the business can add to its assets and create value for its shareholders.
The reasons why positive cash flow is vital for a business, are:
- Helps make better decisions for the future: Knowing the exact amount of money going in and out of the company allows its management to make decisions based on accurate information. Being cash flow positive provides the platform to make significant purchases for the company's future.
- Helps in taking expansion decisions: Business expansion can be risky, as it involves spending large amounts of cash required to grow a business. Effective cash flow management indicating a positive cash flow can help an organisation's leaders determine the most appropriate time for expansion.
- Helps maintain good business relationships with third parties: Being cash flow positive can avert awkward situations where there aren't enough funds available to pay suppliers, contractors, or other third parties and help maintain a good relationship with them.
How do you make your business cash flow positive?
To become cash flow positive, liquid assets or cash generated from the company's operating activities must exceed the money spent to keep it running. If your business is struggling with cash flow, here are a few measures to make your business cash flow positive:
- Maintaining a buffer fund: The first pillar of positive cash flow is always to be prepared for the worst. That’s why it’s essential to have some buffer cash on hand. Most accountants usually advise a minimum of one month’s operating expenses as an available cushion or at least have enough money to cover the next payroll period.
- Improving your receivables: Outstanding invoices and delayed client payments are the biggest cash flow hurdles, especially for small businesses. Measures can be taken to improve cash collection by encouraging clients to pay on time (follow-up and execute late penalties on invoices) and being proactive about payment collection (setting up online payments and auto-pay functions).
- Managing your payables: You can negotiate your accounts payable with vendors. Restructuring your payments to vendors creates a more balanced income for your business. Also, cut unnecessary expenses that do not add value to your business.
- Paying taxes regularly: Evade a windfall of expenses by assessing and regularly paying off estimated income taxes to the state and federal authorities every quarter.
- Reviewing business operations: Several business operations can be reevaluated and updated for efficiency. Identifying processes that can be outsourced helps in substantial cost-cutting. Apart from outsourcing, you should continuously monitor, evaluate, and improve other areas of operation to determine efficiency gaps to enhance savings.
- Managing inventory effectively: Effective inventory management is critical to improving cash flow. Particularly for a small business, inventory is equivalent to cash; the business owner should adjust inventory as needed and turn inventory quickly.
- Reviewing finance/loan options: Various options available for financing to obtain extra funds should be carefully evaluated. Options, such as loans from banks/non-banks, invoice financing, invoice factoring or business line of credit, must be weighed carefully before you finally zero down.
Does positive cash flow imply that the business is profitable?
Cash flow positive vs profitable: Cash flow is the cash a company receives and pays, but profit is the total revenue after disbursing all business expenses. Although being cash flow positive in most situations implies that the company is incurring profits, the two aren't the same.
Sometimes, a business can be cash-flow positive but may not be profitable For instance, if a business operates at a net loss, borrowing cash helps create a positive cash flow. Similarly, when it sells a significant asset to raise capital, the money it receives is an inflow of cash. In both cases, the business is cash flow positive but not profitable.
Similarly, in the case of a start-up business, a positive cash flow doesn't necessarily prove that the company is profitable. The liquidity could result from factors other than profit (loan funds or stocks sold at a loss, etc.).
- Cash flow positive vs break-even: The break-even point is when the business's profit equals zero, and cash flow is neither positive nor negative. At this point, the total cash outflow equals the business's cash inflow.
- Cash flow positive vs negative: Cash flow is deemed negative when a business has more cash outgoing than the money coming in. In a cash flow negative situation, a company cannot cover its expenses from its sales alone. Instead, it requires funds from assets and financing to bridge the difference.
Key takeaways
Being cash flow positive implies that the business is liquid or solvent.Businesses should ensure that their revenues exceed expenses, creating a positive cash flow and generating profit.
While there’s no magic wand or switch you can flip to turn your business cash flow positive overnight, you can surely take the needed steps to manage your cash flow.
Becoming and remaining cash flow positive is a long-term business journey. Remaining alert, frequent cash flow monitoring and tracking, and making all necessary corrections shall eventually take you there.
FAQs
Positive cash flow indicates that a company's liquid assets are increasing. This enables it to settle debts, reinvest in its business, return money to shareholders, pay expenses, and provide a buffer against future financial challenges. Negative cash flow indicates that a company's liquid assets are decreasing.
Why is positive cash flow important? ›
With a positive cash flow, managing your costs will be simple. You'll know exactly what is coming in and when, so you can set up payment terms on your outgoings that won't be missed. If you're struggling to pay your business costs and debt every month, it's time to improve your cash flow.
Which cash flow is the most important and why? ›
Operating cash flow (OCF) is the lifeblood of a company and arguably the most important barometer that investors have for judging corporate well-being. Although many investors gravitate toward net income, operating cash flow is often seen as a better metric of a company's financial health for two main reasons.
What is the purpose and importance of cash flow? ›
Cash flow statements are essential for your financials. They show us how well a business uses it's cash and how healthy its operations are. A good cash flow analysis will tell you if a company can pay its bills on time and if it has enough cash to sustain operations in the future.
Why is cash flow statement more important? ›
A cash flow statement is a valuable document for a company, as it shows whether the business has enough liquid cash to pay its dues and invest in assets. You cannot interpret a company's performance just by looking at the cash flow statement.
What does a positive operating cash flow indicate? ›
Working capital is essential because it represents a company's ability to pay its short-term debts and meet its financial obligations. A business with a positive operating cash flow typically has sufficient working capital to cover its short-term debts and expenses.
What does a positive cash flow from financing activities tell us? ›
If cash flow is positive, that means the business has engaged in more new debt or equity financing activities that bring cash in than it engaged in debt repayments. This is a great thing for cash on hand, as it may allow the business to expand, or stay alive during early-stage product development.
Why is money flow important? ›
Having a positive cash flow means that more money is coming into the business than going out. It's just as important as profit when it comes to determining your business' performance.
What is cash flow in simple terms? ›
Cash flow is a measurement of the amount of cash that comes into and out of your business in a particular period of time. When you have positive cash flow, you have more cash coming into your business than you have leaving it. When you have negative cash flow, the opposite is true.
What is positive cash flow vs profit? ›
Profit is defined as revenue less expenses. It may also be referred to as net income. Cash flow refers to the inflows and outflows of cash for a particular business. Positive cash flow occurs when there's more money coming in at any given time, while negative cash flow means there's more money out.
Cash flow forecasting involves estimating your future sales and expenses. A cash flow forecast is a vital tool for your business because it will tell you if you'll have enough cash to run the business or expand it. It will also show you when more cash is going out of the business than in.
When and why should you do a cash flow? ›
A cash flow forecast is an estimate of your future sales and expenses. It is a useful tool to help you understand if you will have enough income to cover your expenses. This will help you prevent cash shortages and avoid debt.
Why is cash flow control important? ›
Maintaining healthy cash flow ensures that a business has enough liquid assets to meet its short-term obligations, such as payroll, rent, and supplier payments. This liquidity is essential for the day-to-day operations and overall solvency of the business.
Is cash flow the most important thing? ›
Cash flow and profits are both crucial aspects of a business. For a business to be successful in the long term, it needs to generate profits while also operating with positive cash flow.
Why is cash flow more important than income? ›
Cash flow statements are a good barometer of whether your debt levels are sustainable and whether your cost of debt is manageable or not based on your sustainable operating cash flows. Remember, you need real cash to pay your debts and book profits are not sufficient.
How to interpret a cash flow statement? ›
To interpret your company's cash flow statement, start by looking at the inflows and outflows of cash for each category: operating activities, investing activities, and financing activities. If all three areas show positive cash flow, your business is likely doing well (although there are exceptions).
What are the benefits of positive free cash flow? ›
The upshot: Positive free cash flow means you have sufficient money to invest back into the business for growth or to distribute to shareholders. Negative free cash flow could portend that you'll need to raise money to pay the rent or there's a potential for healthier competitors to outperform you in the market.
Why is it important to have accurate cash flow? ›
An accurate cash flow forecast helps you to predict future cash positions, avoid cash shortages, and earn returns on any cash surpluses you may have, in the most efficient way possible.
Why positive cash flow from investing activities? ›
Positive and Negative Cash Flow from Investing Activities
Purchasing stocks, bonds, securities, debentures, and other instruments – negative cash flow. Selling off or leasing out fixed assets, including plants and machinery – positive cash flow. Selling off securities within a brief time bracket – positive cash flow.
Why is cash flow important in a project? ›
Cash flow is crucial in construction projects, as it affects the project's ability to meet financial obligations, maintain cash reserves, manage risk, and stay on schedule. A positive cash flow helps contractors to pay for materials, labor, and other expenses on time, avoiding delays and interruptions in the project.
