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What is cash flow?

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Last editedSep 20213 min read

Definition of cash flow

Cash flow is the rate at which money passes into, through and out of a business over a given time period. It's a vital metric that can tell you a lot about the health of your business.

Cash flow is all about the movement of money. It doesn't include capital in the bank, or credit from suppliers (at least not until payment is actually made) or debtor amounts (because the money isn't yours until it's been paid). Those things may affect the cash flow of a business, but they don't define it. Cash flow is concerned with the actual flow of money over a period of time.

Cash flow can tell you a lot about the health of your business – and any other business, for that matter. Used by investors and bank lenders as well as business owners, it’s one of the most important ways of telling whether a business is healthy or not.

Cash flow example

If a retail business received $20,000 for sales in a one-month period, and spent $16,000 on wages, stock, rent and other expenses in that time, it would have a $4,000 positive cash flow for that period.

If the same business only received $15,000 for sales during the month but had the same expenses, it would have a $1,000 negative cash flow – which could be a warning sign.

Why is cash flow important?

It's possible for a business to look good on paper, with plenty of orders, relatively low operating costs and a good profit margin, yet be struggling in reality due to poor cash flow.

A business with a good cash flow has more than enough money coming in to cover its expenses. By contrast, a struggling business may be living from day to day, waiting desperately for its debtors to pay up before its creditors take it to court.

“Cash flow is definitely the number one concern a lot of small businesses have. When talking at an event or networking meeting, it always comes up. It's right up there with concerns about staffing and premises, and linked to them as well. Cash flow underlies a lot of different areas of the business when growing. Poor cash flow can hold companies back, can make or break them.” - Ben Nacca, Cone Accounting

You can think of cash flow as being like the flow of water into and out of a lake, with some rivers feeding into it and others flowing out of it. If the inflow and outflow of water are roughly equal, the lake will remain at a constant level. If the outflow is greater than the inflow, the lake level will drop, and it may eventually dry up altogether.

Applying this analogy to a business, if the flow of money in is equal to or greater than the flow of money out, the business should be reasonably healthy. However, if the flow of money out is greater than the flow of money in, then over time the business will find itself in difficulty. In fact, poor cash flow is one of the strongest indicators that a business may fail, and has been the cause of countless bankruptcies.

“It is definitely a major issue. Having suppliers calling and emailing chasing for money, or even stopping supply due to non-payment, is extremely stressful for business owners. Stop supply can impact their ability to run their business. Obviously we can see this from the suppliers' side too – they must be paid! So it ends up being a vicious cycle.” - Sarah Stein, Miss Efficiency Bookkeeping

What is the impact of poor cash flow?

Research by GoCardless shows just how much of an impact poor cash flow can have. 80% of respondents said they couldn’t be sure they’d be able to pay their bills on time due to unpaid invoices negatively impacting cash flow. 89% of business owners said uncertainty around when payments would come in made them more stressed and anxious.

Poor cash flow can lead to serious stress for the business owner, especially when dealing with larger companies that take a long time to pay, according to Alex Falcon Huerta of Soaring Falcon:

“It can even lead to hospitalisation. We've seen clients so stressed because it's their life, they've put their own money into the business. It can be really awful – people don't see that side of running a business.”

For some businesses, especially larger ones with good cash reserves, cash flow isn't an existential risk. However, it can still limit growth potential, preventing expansion into profitable new areas and limiting business agility. This can be true even in companies with dedicated teams managing accounts receivable and accounts payable, if the business strategy isn't fully optimised.

Learn more about the reasons for poor cash flow and ways you can improve cash flow efficiency.