What Is Cash Flow?

What cash flow means in plain words

Think of your business bank account as a water tank. Customer payments, loans and investment flow in. Rent, wages, suppliers and taxes flow out. Cash flow describes whether the tank is filling or draining during a given week, month or year.

It is different from profit. Profit is recorded when you make a sale, even if the customer has 60 days to pay. Cash flow only counts money when it lands in or leaves the account. That gap between earning money and receiving it is where many young businesses get into trouble.

How to calculate cash flow

Accountants split cash flow into three groups, and you will see them on a formal cash flow statement:

• Operating: day-to-day trading. Customer payments in, suppliers, wages and rent out.
• Investing: buying or selling long-lived things such as equipment or a vehicle.
• Financing: money from loans, investors or your own savings coming in, and loan repayments or owner withdrawals going out.

For a new business, operating cash flow is the one to watch. It tells you whether the business can fund itself from trading.

A worked example

This is a made-up illustration. Say you run a small design studio and start March with $5,000 in the bank. You finish a $6,000 project in March, but the client pays 30 days after the invoice. Meanwhile you pay a freelancer and your usual bills.

On paper, March was a profitable month: $6,000 of work against $3,500 of costs. In the bank, March was a $3,500 drain. If you had started with $3,000 instead of $5,000, you could not have paid your bills, even though the work was profitable.

Why cash flow matters for a first-time founder

You meet cash flow the moment you start spending before you start earning, which is almost every new business. While cash flow is negative, your monthly shortfall is your burn rate, and the months you can keep going is your runway. The startup runway calculator turns those two into a date.

Cash flow also shapes which idea you choose. A consulting business gets paid soon after the work and needs little upfront. A product business may pay for stock months before the first sale. Neither is wrong, but the second needs more starting cash. The startup cost calculator helps you estimate how much.

Later, a cash flow forecast becomes part of your financial plan. If you want to see where it sits among the other chapters, read how to write a business plan for a startup. In Fonda's journey, the Business plan step sits in the Launch phase, after your idea has a Verdict, which is a sensible point to build your first forecast.

How to build a simple cash flow forecast

1. Open a spreadsheet with one column per month for the next 12 months.
2. Enter your opening bank balance.
3. List the cash you expect to receive each month, in the month it will be paid, not the month you send the invoice.
4. List every payment in the month it leaves the account, including annual bills and taxes.
5. Subtract payments from receipts to get net cash flow, and carry the closing balance into the next month.
6. Look for any month where the balance goes below zero, and plan for it now.

Common mistakes

• Treating profit as cash. An invoice is not money until it is paid.
• Forgetting irregular bills. Annual software, insurance renewals and tax payments arrive in lumps.
• Growing too fast. More orders can mean buying more stock and paying more staff before customers pay you.
• Mixing personal and business money. One account for both makes it impossible to see how the business is doing.
• Forecasting once. Update the forecast each month with what really happened.