What is cash flow and how does it actually work?

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Setting up your own business is the start of an exciting new adventure! 💪

You’ve probably thought about a business plan, your brand and if you need a business bank account. Now you might be thinking about sorting out accounting for your business and understanding how cash flow works.

We’ve outlined why cash flow might be important to you, what types of cash flow exist and how to manage your cash flow as a small business.

What is cash flow?

  • Cash flow is the net amount of money that flows in and out of bank accounts. In this case that bank account would be your business bank account over a period of time. 

  • Net cash flow is how much money your business gets in, minus the amount that goes out over a period of time. 

Lots of businesses have the goal of having a positive cash flow. A positive cash flow means more money goes into your business than out of it during a given period of time. This will let you pay off any liabilities you have and also can help grow your business by hiring more people or buying more equipment.

Even though they might sound similar, positive cash flow isn’t the same thing as profit. 

  • Profitability is when your business revenue is greater than all the expenses needed to help you make that revenue. You might use it to measure the success of your business. 

  • Positive cash flow lets your business keep operating day-to-day. 

Negative cash flow is when the cash flowing out of a business is higher than the cash coming in over a period of time. This may be caused by a temporary discrepancy between how much you’re spending and how much money is coming in. It doesn’t always mean loss, but long-term negative cash flow could suggest your business is losing money. 

What is free cash flow?

Unlike net cash flow, free cash flow (FCF) is the money left over after your business has paid for its operating expenses and capital expenditures (CapEx). Capital expenditure is the money your business spends to upgrade, buy or maintain stuff it owns, like the business property or tech equipment.

Free cash flow is a measure of how efficiently a company makes cash. Investors sometimes look at it to see if the business might be able to pay investors through dividends.

Why is cash flow important?

As a small business, your expenses and other things you spend money on may outweigh the money coming in from sales or customers who are paying you. Cash flow management is important to your overall business health and your business strategy. And this can be especially important if your business is seasonal or if it’s open to fluctuating cash inflows throughout the year. 

There are three different types of cash flow

There are three types of cash flow: 

1. Operating

Operating cash flow – or cash flow from operating activities – is the amount of cash your business makes from its normal operations. This can be something like manufacturing and selling goods or providing a service. It depends on what your business does! You calculate it  by taking away the cash you pay to suppliers from the cash you generate from customers.

Cash inflow (money coming into the business) can be from operating activities like money you make from selling goods and services and any interest or dividends from any loans or investment.

2. Investing

Investing cash flow – or cash flow from investing activities – is the amount of cash that you’ve spent on, or made from, investments over a particular period. These could include buying physical assets (such as property or equipment), buying another business or investments in securities.

Cash inflows from investing activities can often be from the business selling property or equipment you own. 

3. Financing

Financing cash flow – aka cash flow from financing activities – is the net amount of funding your company makes to finance its business over a given period. This includes proceeds gained from transactions involving debt, equity, and dividends.

Cash outflows (money going out of the business) from financing activities include the repayment of loans and payments to owners, among these are cash dividends. 

How to understand the cash flow statement

You can calculate cash flow by using a cash flow statement. This is a financial statement that helps you look into your business’ cash inflows and outflows over a period of time.

The statement has three parts to it:

  1. Operating cash flow (this includes operating expenses like payment for utilities)

  2. Investing cash flow

  3. And a section on financing cash flow (all three added together makes up net cash flow). 

A cash flow statement is often useful to investors because even profitable businesses can have cash flow issues. It gives a full picture of a company’s cash flow, so it can help investors look at the value of its stock or the business as a whole.

How to track cash flow using Monzo

Monzo Business lets you neatly separate your money to suit your business, all in one account. 

You can set money aside in Pots for things like overheads, budgets or other business costs – instead of opening a new bank account every time. And you can move money in and out of Pots whenever you need, so you're always in control of your cash flow.

If you have a Monzo current account– you can sign up straight from the app 👇

If you don't have a Monzo account already – download the Monzo app to sign up for a free current account. Then head to your account and tap 'Apply for a business account.' 👇

Find out more about how Monzo Business can help you manage your cash flow here.

How to improve your cash flow

Having a positive cash flow can impact your business’ future. If you’re looking to make a start on improving your cash flow, you could 

  • Make sure you’ve collected all the money clients might owe you. 

  • Try to slow down your payables (how much money you’re spending on paying for things) as much as possible. 

Another way to improve your cash flow is by forecasting what your cash flow will look like in the future, by seeing where it stands right now. This can be a good way to evaluate your customer and supplier terms to check they’re balanced and working in your favour. 

If your cash flow isn’t improving because customers are slow at paying you, you could look into tightening your terms of credit or late payment fines. 

Working on increasing your sales and growing your customer base can result in more cash to cover your expenses, and lead to a positive cash flow.