Cash flow provides a better understanding of a firmâs 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.
Having positive cash flow is crucial for any business to survive and thrive. But what exactly does it mean to be cash flow positive?
In simple terms, a business is cash flow positive when it has more cash coming in than going out over a certain period of time. This means the net cash inflows from sales and other activities exceed the total cash outflows from expenses, debt payments, investments etc.
Being cash flow positive indicates a business has enough liquidity to meet its obligations without needing external financing It is an important sign of financial health and stability
In this comprehensive guide. we will explore in detail
- What cash flow positive means
- Difference between cash flow and profitability
- Why positive cash flow matters
- How to calculate if you are cash flow positive
- Tips to improve cash flow and become cash flow positive
What Does Cash Flow Positive Mean?
Cash flow refers to the net amount of cash entering and leaving a business during a defined time period. It is the money that flows in and out as a result of conducting day-to-day business operations.
Positive cash flow simply means more money is coming into the business from customers, clients or other sources than the total cash going out for paying expenses, creditors, taxes etc.
If the cash inflows consistently exceed outflows, it leads to a cash surplus. This surplus cash can be used to expand the business, pay off debt or save for future needs.
On the other hand, negative cash flow occurs when outflows exceed inflows. The business spends more than it earns, leading to a cash deficit. Prolonged negative cash flow can severely impact a company’s survival.
Positive cash flow enables a business to meet its financial obligations without needing loans or dipping into savings. It provides financial flexibility to invest in growth and manage unexpected expenses.
How Cash Flow Differs from Profit
Positive cash flow is often confused with profitability, but they are not the same. Profit refers to money left after subtracting total costs from total revenues over a period.
Cash flow focuses on the timing and amount of cash moving in and out. A profitable company can have cash flow problems if the timing of cash inflows does not match with outflows.
For example, a business can have $100,000 in sales and $80,000 in expenses during a month. This gives a profit of $20,000.
However, if only $70,000 is collected from customers while $80,000 is paid out, the company will have negative cash flow of $10,000 that month despite being profitable.
So you can see why cash flow matters more than profitability in terms of short-term liquidity and survival. Monitoring cash flow gives a real-time view of your finances as compared to delayed profit calculations.
Why Is Positive Cash Flow Important?
Maintaining a positive cash flow position is vital for any business for several reasons:
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It allows you to meet financial obligations – Positive cash flow ensures you can pay employees, suppliers, lenders and handle day-to-day expenses as they become due without defaulting.
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It gives you financial flexibility – With surplus cash, you have the flexibility to invest in new equipment, hire more staff, give raises or expand your business into new markets.
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It helps manage growth – Growth requires upfront investment in inventory, people or facilities. Positive cash flow provides funding for such investments.
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It builds business resilience – Having liquid reserves helps deal with unexpected events like an economic downturn or emergency expenses without taking on debt.
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It improves access to capital – Lenders and investors look at consistent positive cash flow as a sign of creditworthiness and investment potential.
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It prevents insolvency – Negative cash flow drains your liquidity over time and can lead to insolvency and bankruptcy if sustained long enough.
In short, being cash flow positive is essential for any business to operate, settle obligations, withstand shocks, fund growth and build long-term viability. It directly impacts your chances of survival and success.
How To Calculate Cash Flow
To determine if your business is cash flow positive, you need to calculate your cash flow for a specific period, such as monthly or quarterly. Here are the key steps:
Step 1: Calculate your cash balance at the start of the period from your bank and book balances. This is your opening cash balance.
Step 2: Add up all cash received during the period. This includes cash sales, collection of receivables, interest income, loan proceeds etc.
Step 3: Add up all cash paid out during the period. This includes payments for inventory, wages, taxes, loan repayments, operating expenses etc.
Step 4: Subtract total cash paid out from total cash received. A positive number indicates positive cash flow for the period. A negative number means negative cash flow.
Step 5: Add the cash flow amount from Step 4 to your opening cash balance. This gives you the closing cash balance.
Step 6: Compare closing balance to the opening balance. If the closing balance is higher, your cash flow is positive for that period. If it is lower, your cash flow is negative.
Let’s see an example:
Opening cash balance (1/1): $10,000
Cash received (Jan):
- Cash sales: $5,000
- Collected receivables: $15,000
- Loan received: $10,000
Total cash received = $30,000
Cash paid (Jan):
- Inventory purchases: $20,000
- Wages: $5,000
- Rent: $2,000
- Loan repayment: $3,000
Total cash paid = $30,000
Cash flow (Cash received – Cash paid) = $30,000 – $30,000 = $0 (Step 4)
Closing balance (Opening balance + Cash flow) = $10,000 + $0 = $10,000 (Step 5)
Since the closing balance equals opening balance, the cash flow for January is neutral or balanced (neither positive nor negative).
Regularly monitoring cash flow this way lets you determine if you have a surplus or deficit each period. Accounting software like QuickBooks can automate the calculation.
Tips To Improve Cash Flow
If your business cash flow is negative or neutral, here are some tips to help improve it:
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Speed up invoicing and collections – Invoice clients promptly and follow up on unpaid invoices. Offer payment plans or discounts for early payment.
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Control inventory – Don’t overstock inventory. Use just-in-time ordering to align inventory costs with sales.
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Extend payables – Pay your bills and vendors more slowly. This preserves cash longer.
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Manage expenses – Review expenses regularly and cut non-essential ones. Avoid large upfront outlays.
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Smooth out seasonality – If your business is seasonal, build up cash reserves during peak seasons to cover low seasons.
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Get a working capital loan – Short term loans like a business line of credit can help cover cash flow gaps.
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Offer new products/services – Generate more revenue streams to boost cash inflows.Upsell to existing customers.
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Lower taxes – Claim relevant deductions and tax credits to reduce tax outflows.
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Invoice factoring – Sell your accounts receivable to a factoring company to convert them quickly into cash.
With active cash flow management using these tips, you can go from negative to positive cash flow.
What To Do If You Are Cash Flow Negative?
If your business cash flow is consistently negative, you should take prompt corrective actions such as:
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Review sales and collection processes to generate cash faster
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Renegotiate repayment terms with suppliers and lenders
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Cut discretionary expenses like travel, marketing etc.
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Liquidate idle inventory and assets to raise cash
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Delay planned capital expenditures if possible
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Ask investors for interim capital injections
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Obtain a short-term loan to bridge the cash deficit
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Run cash flow projections to determine how much financing you need
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Develop a cash flow budget to better control inflows and outflows
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As a last resort, consider declaring bankruptcy if cash deficits persist
Turning around negative cash flow requires making tough decisions on reducing costs, improving sales, and securing new financing. Acting quickly gives you the highest chance of restoring positive cash flow and avoiding insolvency.
Being cash flow positive should be a top priority for any business owner. It provides freedom to operate smoothly, take advantage of opportunities, and build a sustainable venture.
Monitoring your cash flow helps identify shortfalls before they become chronic issues. The tips shared above can improve most cash flow situations with diligent application.
However, if the business model itself is unviable, negative cash flow may be unavoidable without radical changes. Sometimes, the best option is to cut losses and move on.
Consistently maintaining healthy positive cash flow takes great financial discipline. But it is one of the most fundamental requirements for achieving small business success and growth.
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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 companys 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 organisations 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 arent 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 companys 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. Thatâs why itâs essential to have some buffer cash on hand. Most accountants usually advise a minimum of one monthâs 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.
Cash Flows Explained
What is positive cash flow?
Positive cash flow is a business situation when a business experiences more cash inflow than cash outflow. It implies that the business generates more revenue than the expenditure it incurs. This cash flow is essential for businesses to grow and reinvest in their expansion.
What makes a company cash-flow positive?
Therefore, a company is cash-flow positive if more cash goes into its accounts than leaves the same accounts. Why does cash flow matter to a business? Some of the main reasons cash flow is important for a business are:
What is the difference between cash flow positive and profitability?
Cash flow positive meaning: Cash flow positive means that you have more money going into your business at any given time than you do coming out. Profitability meaning: Profitability, on the other hand, measures a bigger picture number. Your profit is what you have left after all of your expenses are paid.
What is the difference between positive and negative cash flow?
The list goes on. Cash flow can be positive or negative. Positive cash flow means a company has more money moving into it than out of it. Negative cash flow indicates a company has more money moving out of it than into it. Operating cash flow: This refers to the net cash generated from a company’s normal business operations.
