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Understanding Cash Flow- Job 1 for business owners

The number one reason businesses don’t make it is insufficient cash flow. Cash flow is ground zero for business planning and obtaining financing. In the early stages of your business, you needed to know how much capital you needed to launch in order to determine if you could self-fund it or needed financing. And the very first question investors or lenders ask is how much capital do you need based on your expected cash flow?

If you understand the factors that determine cash flow, you can thrive. If you don’t, you’ll get blindsided by cash shortfalls and may not survive. Here’s what I want you to know about cash flow.

Cash flow is the cash generated or lost over the course of time, say a year, from the numerous transactions that occur during that time span. If you’re losing cash, you are said to be burning cash and the amount of monthly burn is called your burn rate. This is vital information for business owners and their investors or lenders.

Before I go into more explanation of cash flow, here are the key takeaways from this blog post.

Key Takeaways

Every business needs a reliable cash flow forecast model that can be used repeatedly over the years. There’s an art to creating one and not every accountant does it well. You only want to design it once so it’s best if it’s designed correctly the first time. It must be clear and user friendly for you and your staff. Also, you’ll most likely have turnover in the future and you don’t want a new model created by each successor as that will drive you crazy and be wasteful.

Net income or loss isn’t your cash flow. It’s only one line in the balance sheet and you need to look at the changes in all balance sheet accounts to explain cash flow.

Understanding your cash flows is imperative for you to be a good financial steward and

complete leader. It requires a fundamental understanding of balance sheets.

How to Calculate Cash Flow

To calculate cash flow using your last two year-end balance sheets, take the most recent year end cash balance and subtract the prior year end cash balance. That change is your cash flow. Explaining the reasons for that change in cash which is the result of all your transactions requires analysis of the two balance sheets.

The table below shows balance sheets at two year ends, along with the year over year change and the effect such change had on cash flow.

In the table below, Operating Cash, which is usually the operating bank account and has no restrictions on it, decreased $150,000 so there was negative cash flow of $150,000. That amount is explained by changes in all the other lines below Operating Cash.

For example, Accounts Receivable (AR) decreased $50,000 which had a positive effect on cash flow. The effect is positive because the beginning of the year AR of $150,000 was collected (positive effect on cash flow) and the end of year AR of $100,000 was outstanding (negative effect on cash flow), netting a positive effect on cash flow of $50,000.

Notice that cash flow was negative $150,000 yet net income was positive $200,000. That means that $350,000 of cash was used across all the other lines of the balance sheet except the Operating Cash and Net Income lines.

This is a perfect example of why you can’t look to your P&L for your cash flow. Changes in the balance sheet accounts like Accounts Receivable, Inventory and Accounts Payable affect cash and therefore affect cash flow.

If you have questions about the above table, would like to understand cash flow concepts better, or don’t yet have a reliable cash flow forecast model, please let me answer your questions and help you get the forecast model you need. You can reach me at (305) 467-5909 or at

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