What is Cash Flow
In simple terms, cash flow refers to the movement of cash into or out of an account, a business, or an investment.
Whether you’re an individual, a business or an investor, we all need to be concerned about our hard-earned dollars. The inflows and outflows must be accounted for, and may need alterations on one or both sides of the equations. Can you say you have a positive cash flow? Meaning you have less going out than coming in? If so, fantastic, but what are you doing with that positive cash flow?
To be considered responsible adults, we’re often taught to just have enough to cover our expenses. You know, the basics, the bare minimums. Cover the rent, car payment, light bill, pay the minimum debt payment, save a little or maybe even invest in a 401k or RRSP. But is that really good enough? Surely, we’re not just here to pay bills until we die.
Cash Flow For Businesses
Cash flow is the lifeblood of a business and one of the most important aspects to keep tabs on. The general formula for cash flow is Operating Cash Flow less the Purchase of Property/Plant/Equipment.
We’re familiar with revenue, the money brought in by the sale of goods or services, but there’s much more to it than that.
For a business there are 3 types of cash flows
- Operational ; Cash received or spent as a result of a company’s activities
- Investment ; Cash received or spent through investing activities
- Financing ; Cash received through debt or paid out as debt payments
A company experiences a Cash Flow Crunch when they’re not able to pay all their obligations. This is dangerous as it doesn’t just affect the business, but also the owner and the employees. If a cash flow crunch persists too long, it may result in bankruptcy for the company and individuals.
Questions to ask yourself about your business are :
- Is my operating cash flow greater than profits?
- Is my operating cash flow growing faster than profits?
This is why statements need to be done on a quarterly basis, so that issues may be corrected to hopefully show improvement. The Balance Sheet, Income Statement, and the Cash Flow Statement will be able to provide a good view of the financial health and future of a company.
Cash Flow For Individuals
Do you make enough to cover your bills? Can you say your cash flow is positive, negative, or do you just breakeven? Are there areas that you can tweak and make adjustments to limit your outflows or increase your inflows? Start thinking about yourself as a business and keep account of your financial activities. In order to get ahead, stop considering your bills being covered as your breakeven point, think further.
What are your long-term and short-term goals, what other objectives do you have that you want to make sure you uphold? Are you able to pay cash for all your purchases, or are you relying on credit to make it through the month? See where you have leaks or unnecessary spending that you can cutback or cap.
Your personal inflow can be defined as your income, which may come from your job, a side hustle, an allowance, returns from your investment and so on. Your outflows would be your mortgage payment, rent, car payments and insurance, loans and credit card payments and other expenses. Each month, keep track of your progress and reconcile at the end of the month to see what your spending comprised of. Budget, but take it a step further. Keep your goals consistently at the forefront but adjust your budget accordingly, so that it becomes a working budget.
Hopefully you have funds left over after paying your bills. This cash flow you have remaining is what you can use to accelerate your efforts to achieve your goals. Do you want to pay off debts faster, save for a big purchase, invest in yourself, or invest in real estate? Without having positive cashflow you may find yourself stagnant, and never getting ahead. So, make it a goal to be in the green.
Cash Flow For Investors
When looking to invest in a business, the most critical aspect to look at is the Free Cash Flow of the company. Net Earnings are important, however if the Free Cash Flow is less or even negative, the company is not in good financial health. Picture the cash flow statement as the gas gauge of a car. Do they have enough fuel to keep going, and for how long?
As an investor you’re looking to see how much and what a company does with their Free Cash Flow. What you’d like to see is it being reinvested back into the company, dividends are being paid out, or the company is buying back their stocks(cheaper than the sticker price).
If we’re talking Real Estate, cash flow refers to how much funds are left after all expenses are paid. For most single family homes, the cashflow only results to a couple hundred dollars a month or even a negative cash flow. However, real estate is a different ballgame. Although the cashflow may be low, the equity that is built is the real focal point.
Key Take Aways
- Even though a company shows as profitable, if they don’t manage their cash flow, they may end up having to close their doors.
- Liquidity of your business is what your cash flow will determine.
- Positive cash flow or Free Cash Flow is funds that can be used to expand, reinvest and achieve objectives faster.
Overall, the rule is the same. We want more money coming in than going out. Be wise and intentional with spending. And always seek not just to maintain but to improve.