Understanding Cash Flow: What Is it and How It Works

By UBank
Tuesday, August 29, 2023

Picture this: You’re making more money than ever, but you just can’t seem to find the cash to cover certain expenses. How can both be true at once? What can you do to free up the cash to pay what you owe? Understanding cash flow is the first step. Looking at how cash moves in and out of your life can put you on the right path to financial freedom. And here at UBank, we’d be thrilled to help you explore this, both via this guide and in person at our East Texas branches.

What is cash flow?

Cash flow is the amount of actual money, as well as cash equivalents (interest-earning assets), that move in and out of an entity. We’re saying “entity” here because the term “cash flow” is typically used in business settings, but it has value for your personal finances too!

An example should help here. Let’s say you’ve earned $4,000 in net income (take-home pay) from your job this month. Let’s also say you’ve spent $3,000 this month — some toward fixed expenses like rent and and some toward variable expenses, like your grocery bill. We’d then say your cash inflows are $4,000 and your cash outflows are $3,000.

Now, let’s also say that you already had $2,500 in your bank account. This is your starting cash balance for the month. Add your cash inflows to that, then subtract your cash outflows, and you’re left with $3,500. This represents a $1,000 increase — or $1,000 in positive cash flow. Similarly, a $1,000 decrease would be dubbed $1,000 in negative cash flow. In short, calculating your cash flow tells you the actual amount of cash you’ve lost or earned during a period.

This brings up a major point of distinction: Cash flow and profit aren’t one and the same. Profit is the amount of your revenue left after you deduct expenses. You could have $1,000 in positive cash flow but $2,000 in expenses remaining to be paid and thus a negative profit. If cash flow is all about actual cash balances, profit is all about whether you earn or lose money to get that cash.

The importance of cash flow

Figuring out your cash flow is how you see whether your cash and liquid assets (those that you can easily convert to cash) are growing. Positive cash flow indicates this growth, and growth means you’re continuing to have enough cash or liquid assets available to cover your expenses. It also means you have enough extra money to put toward emergency savings and investing activities. These investments could be tradable assets or, if you’re running a small business, expansions and upgrades such as hiring new staff and implementing new technology.

If you’re looking at cash flow from business activities, positive cash flow means that, in addition to the above, you can pay returns to shareholders. This shows potential future shareholders that you can earn them money too if they invest with you. The possibilities this opens for obtaining additional business funding are pretty much endless.

The key takeaway here is that, for both business and personal finances, positive cash flow is cause for celebration — and, often, some new investing! On the other hand, negative cash flow indicates financial instability and makes it important to decrease your spending.

The components of cash flow

There are several types of cash inflows and cash outflows — dollars and cents aren’t one-size-fits-all. For personal finances, cash inflows include take-home pay from your job, additional income from side hustles, and personal loans. In business operations, cash inflows include the money customers pay for your products or services (your sales revenue) and any business loans you receive. For both, investment earnings are also cash inflows.

For your personal finances, your cash outflows are easy to pinpoint. They’re literally any money you spend, whether on basics like housing payments or fun things like fancy restaurant meals. It gets a bit more granular when you look at businesses. There, cash outflows include operating expenses, loan repayments, and capital purchases.

Taxes are also a major cash outflow for both personal and business finances. They’re often easiest to handle if you’re an employee at a company rather than a contractor or business owner. In that case, taxes automatically come out of your paychecks — no need to account for regular tax payments!

What this all means is that you can break down your outgoing and incoming cash by category instead of viewing it as one big picture. For example, you can see how changes in your business’s operating expenses increase or decrease the cash you have on hand for emergency savings. The easiest way to do this is with a cash flow statement.

Understanding cash flow statements

In business operations, a cash flow statement is a report showing how your company earns and spends money. (These statements get so detailed that they’re needlessly complex for use with personal finances.) This financial statement includes starting and ending balances alongside two columns. Each cash outflow or inflow line item goes in the left column, with its amount in the right column.

You’ll also see in a cash flow statement that each of the three types of cash flows below has its own section.

  • Cash flows from operation (CFO). Also known as “operating cash flow,” CFO includes all inflows and outflows pertaining to creating and selling your products or services. It shows whether your business is bringing in enough cash to cover its expenses. To calculate it, just subtract all the cash you’ve paid toward expenses from all the cash you’ve earned from sales.
  • Cash flows from investing (CFI). Aka “investing cash flow,” CFI shows how much money you’re spending or earning from investment opportunities. These include more than stocks and bonds — they also include equipment and property purchases. Since these cost more than a pretty penny, it’s totally normal for your CFI to be negative.
  • Cash flows from financing (CFF). Aka “financing cash flow,” CFF covers all debt, equity, funding, and shareholder payment inflows and outflows. For example, you’ll record a new loan’s amount as a cash inflow and dividend payments as outflows. The more positive your CFF, the stronger your company’s financial standing.

A real-life example might help you see how this all plays out. Amazon’s 2020 cash flow statement, courtesy of Shopify, shows a slew of CFF, CFI, and CFO inflows and outflows. Plus, it shows how Amazon’s cash on hand increased substantially year-over-year between 2019 and 2020. This is the essence of why we’re talking about cash flow in the first place. It’s a great way to see whether you’re truly spending money in ways that earn you money.

How cash flow is managed

If you’re looking at your personal finances, managing cash flow is simply a matter of finding ways to earn more income and spend less money. You could set a budget with strict caps on certain categories while starting to freelance outside your job. Or you could ask for a raise at your job and set a broad but still clearly defined goal to curb your discretionary spending.

Our point is that the steps you might already be thinking of taking are great for personal cash flow management. It’s more complex for a business owner conducting cash flow analysis for their company. This business owner’s cash flow analysis starts with the below considerations. You can borrow from this as needed to review your personal cash flow.

  • Streamlining inventory management. If a business sells products, how can the company spend less money on more raw materials? Better yet, how can the business buy only the amount of materials it needs — no more, no less? Improved inventory management, with a strong focus on robust recordkeeping, is a great starting point for answering these questions.
  • Getting clients to pay their invoices sooner. The total amount that clients owe to a business is called accounts receivable. In some ways, this figure is the difference between profit and cash flow. It’s the cash inflow the business could have but doesn’t yet have, solely because clients haven’t yet paid it. As such, getting clients to make timely payments is great for improving cash flow. Early payment discounts and late payment fees are some common ways to incentivize this.
  • Reviewing how the business spends money. This involves checking whether the business is paying vendors in the order of their invoices’ due dates. Doing the same for loan repayments and all other monthly expenses is key too. Rearranging the payment schedule to occur in order of bills’ due dates can minimize late fees that are unnecessary cash outflows. Plus, choosing low-interest business financing in the first place lowers outflows.
  • Assessing operational expenses. Where can money be saved — less advertising? An office that costs less to rent? Making changes to each CFO line item can reduce outflows and, often, increase inflows in tandem.
  • Creating a budget with an emergency fund. Current cash outflows are a great basis for setting caps for each business spending category. This way, spending stays at realistic levels. These caps should inform a plan to direct enough cash inflows to a savings account to cover three to six months of expenses. This is an important fallback in case of an emergency.
  • Get expert help. Money is complicated enough that no one should have to address it alone — that’s why companies hire in-house accountants and bookkeepers. There are more affordable ways to get help managing cash flow too. It all starts with visiting UBank.

Master cash flow with the experts at UBank

Here at UBank, we do more than offer business and personal financial products and services. Our true passion is educating our customers and walking them through key financial decisions. So go ahead and visit your nearest UBank branch to ask all your cash flow management questions. We’re here to answer them and guide you through the best steps you can take for your unique financial situation. You’ll manage your cash flow on your own terms — all with expert help along the way.

Share On: