Cash Flow Basics: A Guide for Small Businesses

March 31, 2023


Before getting into cash flow, one must understand the meaning of cash.

Cash is money available for immediate use, or cash is simply money in the physical form of currency. The most liquid asset any company could own.

Never take your eyes off the cash flow because it's the lifeblood of business.

- Richard Branson, Founder of the Virgin Group.


Why is Cash the King?

# 1 Cash Creates Opportunities

#2 Survival During Economic Slowdown

#3 Emergency Preparation

#4 Faster Bill Payment

#5 Cash Flow

What is Cash Flow?

Positive Cash Flow

Negative Cash Flow

Free Cash Flow

What is a Cash Flow Statement?

Why is Cash Flow Statement Important?

Three Sections of a Cash Flow Statement

How to Prepare a Cash Flow Statement?

Methods of Calculating Cash Flow

Direct Method

Indirect Method

Direct vs. Indirect Method

Income Statement Vs. Cash Flow Statement

Two Important Cash Flow Terminologies

What is Cash Flow Analysis?

What is Cash Flow Forecasting?

Why is Cash the King?

There are stocks, bonds, gold, bitcoin, and NFTs, but why is cash still the undisputed monarch of the business world? Why do intelligent investors like Warren Buffet and Charlie Munger believe in cash? 

Five reasons why cash is still the king!

# 1 Cash Creates Opportunities

The more cash you have, the more opportunities you’ll be able to take advantage of! For example, you’ll not miss any short-term investments that might make you wealthier in the long run. 

#2 Survival During Economic Slowdown

Cash is the undisputed king during a recession because it is easy to navigate the ferocious ocean of economic downfall when you have cash in hand. Unlike stocks and crypto, cash-based accounts bestow insurance to protect your cash. 

#3 Emergency Preparation

Businesses must pay their expenses promptly at certain times of the year. You may have to deal with unforeseen expenditures arising from natural calamities and legal fees. Only cash can get you through such unexpected phases.

#4 Faster Bill Payment

To avoid payment delays that could cause possible dents in profits, some creditors accept payments only through cash. As other forms of payment take longer to process, faster bill payments are made feasible through cash. 

#5 Cash Flow

Cash flow is the most significant factor for any organization. As the author of “Rich Dad Poor Dad,” Robert Kiyosaki, says, “Making more money will not save your problems if cash flow management is your problem.” 

Suppose your business is making a reasonable revenue, but if you’re turning a deaf ear to the expenses and income, i.e., not focused on the financial operations of your business, in that case, a negative cash flow will reach your books. Any great company can go bankrupt if it cannot maintain a positive cash flow in the long run. 

Entrepreneurs believe that profit is what matters most in a new enterprise. But profit is secondary. Cash flow matters most.

– Peter Drucker.

Let us break down the concept of cash flow to help you understand one of the most important financial metrics of all time. 

What is Cash Flow?

According to Investopedia, the term cash flow refers to the net amount of cash and cash equivalents transferred in and out of a company. Cash received represents inflows, while money spent represents outflows.

Important: According to the Corporate Finance Institute, Cash Equivalent is any form of short-term investment security with a maturity period of 90 days or less.  

Positive Cash Flow

Fred Adler, the Forbes director and venture capitalist, once famously said that “happiness is a positive cash flow.

It is the net balance of a business’s cash flow statement greater than zero for a given period of time. Simply put, the cash or liquid assets obtained from several operating activities exceed the cash spent. In that case, to keep it functioning.

For example, Let's say Bob runs a small coffee shop. During December, Bob’s business generated $5,000 in revenue from selling snacks and coffee. But he would have also spent $1,500 on supplies, rent, and employee wages. 

Bob’s cash flow for December is calculated as follows:

Cash inflow: $5,000

Cash outflow: $1,500

Net cash flow: $5,000 - $1,500 = $3,500.

Here, Bob has a positive cash flow of $3,500 for December. So, he has $3500 in extra cash, which can be used to reinvest in his business, save for future expenses, and pay off debts. If he can maintain a positive cash flow consistently, it is a great sign that Bob’s business is financially healthy. 

Negative Cash Flow

If your business has less incoming money than outgoing money, it is negative cash flow. You need to find a way to balance income with your expenses. Because it is highly unlikely that you’ll cover your expenses from sales alone, as you might need financing and investments to keep the machine running.

For example, again, let’s take the example of Bob’s coffee shop. During December, Bob witnessed a positive cash flow. But after Christmas break, Bob’s business faced a negative cash flow problem. In January, his plan to renovate the interiors of the coffee shop to impress his customers backfired. 

Bob’s sales revenue for January was $10,000, but his total spending exceeded $12,000. It means Bob has a negative cash flow of $2000. 

But short-term negative cash flows are not a huge problem. If Bob’s one-time investment tends to work in his favor and brings in more customers from the next month, his negative cash flow will turn into a positive one.

Free Cash Flow

The cash left for spending on important purposes like paying dividends, investing, or reducing debt after a company pays for its capital expenditures (CapEx) and operating expenses (OpEx) is the simple definition of free cash flow. 

For example, let’s assume “Fluffy Bakers” generates an annual turnover of $70,000.

The company invests $30,000 in capital expenditures to purchase equipment and new machinery. 

Free Cash Flow = Operating Cash Flow (OCF) - Capital Expenditures (CapEx)

Free Cash Flow = $70,000 - $30,000

Free Cash Flow = $40,000

Fluffy Bakers generated $40,000 in free cash flow in that year after accounting for its capital expenditures. Analysts and investors see free cash flow as a direct indication of a business’s financial performance. A firm with a solid free cash flow usually withstands economic downturns and will also look into development opportunities in the long run.

By now, you would have understood the importance of cash flow, positive cash flow, negative cash flow, and free cash flow. Next, we’ll discuss the statement of cash flows or cash flow statement.

What is a Cash Flow Statement?

A cash flow statement is a crucial financial management tool to measure an organization's cash flow. It shows precisely how cash comes in and goes out of a company. 

Why is Cash Flow Statement Important?

A cash flow statement is important because you get a deeper insight into your spending habits, the idea for your short-term planning, a bigger picture of cash planning outcomes, a report for crisis management, and an analysis of your working capital. 

As you’ve now understood the basics of cash flow, let us help you prepare a cash flow statement. Before preparing a cash flow statement, you must know about a triad! A set of three crucial cash flow metrics that determine your cash flow performance.

Your business needs to know where the cash is coming from! 

  • Is it a bank loan?  

  • Is it coming from an increase in sales?

That is why cash flow is grouped into three sections. 

  • Cash from Operating Activities

  • Cash from Investing Activities

  • Cash from Financial Activities 

Three Sections of a Cash Flow Statement

Three sections of a cash flow statement

  1. Cash from Operating Activities:

The amount of money a business has made from its operations. Most of the time, when companies mention cash flow, they’re referring to Cash from Operations (CFO). 

CFO = Amount received from sales - Cash paid to employees and suppliers + Interest paid on debt + Taxes paid to the government.

CFO is a company’s operating profit; if the CFO increases, the business growth increases. Simply, CFO is directly proportional to the growth of a business.

  1. Cash from Investing Activities

The purchase or sale of longer-term assets will come under cash from investing activities. For example, purchasing a property or plant or selling/buying a piece of equipment. 

Any money that is spent on improving the business comes under this category. It can be done to maintain a company’s current assets, invest in different securities or acquire a new business. 

For example, suppose you’re running a bakery, purchasing a delivery van, buying adjacent land to improve your stores’ space, or investing in money-market investments (short-term debt investments). In that case, it should be calculated under Cash From Investments (CFI).

This section can be split into two. One for business growth and the other for maintenance activity to keep the business running. CFI can rarely be positive! Either the business received cash from selling assets or from investing activities that worked well in their favor. 

  1. Cash from Financial Activities 

Money raised from shares, bonds, and other forms of debt come under this category. In this cash flow section, you’ll have to deduct three components. Share buybacks, dividend payments, and the company’s principal repayments on their debt level.

If Cash from Financing Activities (CFF) is positive, the business is raising money, and there is growth in its operations. If Cash from Financing Activities is negative, the business is paying out money through share buybacks, dividends, bonds, or principal repayments.  

The net change in cash is reflected by the happenings in these three cash flow sections! Apart from these three, there is “Free Cash Flow.” We’ve already covered free cash flow with an example. Free cash flow is the amount of money left after all the obligations are met! Hope this rhyming explanation stays with you forever. 

If I had to run a company on three measures, those measures would be customer satisfaction, employee satisfaction, and cash flow.

- Jack Welch, Former CEO of General Electric. 

How to Prepare a Cash Flow Statement?

In 2014, Amazon reported a negative earning of -$241M, which means their income statement is screaming, “we’re losing money,” but the cash flow statement of Amazon showed a whopping $5.9B as operating cash flow in the balance sheet.

That’s the difference between a cash flow statement and an income statement. If you want to take a closer look at your finances, prepare a cash flow statement. 

The five steps involved in a cash flow statement preparation:

  • Collecting Financial Information: You need to collect data from several sources, like balance sheets, income statements, and bank statements. Additionally, you should have a clear understanding of cash outflows and cash inflows during the accounting period.

  • Determining the Operating Activities: Find out cash transactions associated with operating activities like purchases, sales, customer payments, payments to suppliers, and expenses during that period. With this calculation, you’ll know the net cash flow from your operating activity. 

  • Determining the Investing Activities: Identify cash transactions associated with investing activities, such as the sale or purchase of long-term assets, loans, or investments. In this way, you’ll know the net cash flow from your investing activity. 

  • Determining the Financing Activities: Find all the transactions associated with financing activities like repaying or issuing loans, repurchasing or issuing stocks, and dividend payments. Now, you’ll get to know the net cash flow from your financing activity. 

  • Preparing the Cash Flow Statement: Now, start preparing your cash flow statement. Summarize the net cash flow from operating, financing, and investing activities. Begin your cash flow statement with the opening balance of cash. Now, you have got the net cash flow obtained from the operating activity. Just subtract the net cash flow from financing and investing activity and end with the closing balance of cash. 

A Cash flow statement example for the year ended December 31, 2022:

Operating Activities: Net Income Add back non-cash expenses: Depreciation Changes in Working Capital: Increase in Accounts Receivable Decrease in Accounts Payable Net Cash Provided by Operating Activities



Investing Activities: Purchase of Property, Plant, and Equipment Net Cash Used in Investing Activities



Financing Activities: Issuance of Long-Term Debt Repayment of Long-Term Debt Payment of Dividends Net Cash Provided by Financing Activities



Net Increase in Cash and Cash Equivalents Cash and Cash Equivalents at the beginning of the Year Cash and Cash Equivalents at the end of the Year


Methods of Calculating Cash Flow

To monitor your company’s financial health, cash flow statements are important. A business can use either a direct method or an indirect method to calculate its cash flow statement. Let’s see what each method is all about, and later will help you make the right decision.

Direct Method

This method involves the calculation of actual cash outflows and inflows for a given amount of time period. Of the two methods, the Direct method is the most accurate. But it takes a lot of time, and also, the implementation is difficult for large companies undergoing tonnes of transactions.

Indirect Method

When it comes to the indirect method, we start with the net income and then adjust it for non-cash items like depreciation and working capital account changes (accounts payable and receivable). An easier method but not as accurate as the former.

Direct vs. Indirect Method

When it comes to choosing the right method, look at your company’s size. If you’re a small business owner handling only a handful of transactions, the direct method is good for you. If you want accuracy, you’ll have to go with the direct method, and investing in accounting software like QuickBooks would be a game changer for your business.

If you’re already a QuickBooks user, you might put in the hard work of entering rows and rows of transactions. If you’re recording your transactions one by one from an excel spreadsheet, you might try SaasAnt Transaction for importing thousands of transactions within minutes. 

You might also want to hire a bookkeeper with Quickbooks experience, and skimming through these ten tips will save you hours of research on the internet.

Revenue is vanity; profit is sanity; cash is king - Anonymous

Income Statement Vs. Cash Flow Statement

According to Investopedia, the income statement and the cash flow statement are integral parts of a corporate balance sheet. A cash flow statement shows the amount of cash a company has generated in a specific period of time, while an income statement shows whether the company made a profit or not.

Know the difference between a cash flow statement and an income statement. You’ll understand the significance of a cash flow statement once you know how it differs from an income statement. 

Income Statement

Cash Flow Statement

Reports the company’s expenses, revenues, losses, and gains for a given period of time (say quarterly).

Reports the company's outflows and inflows for a given amount of time.

A report on the company’s profitability

A report on the company’s liquidity

A detailed info on the cost of goods sold, revenue, operating expenses, gross profit, and net income.

An extensive report on cash from operating activities, cash from financing activities, cash from investing activities, net decrease/increase in cash equivalents, and cash.

Based on an accrual basis (amounts of money which have been spent or earned but yet to be paid)

Based on cash basis

Covers given period of time

Covers a given period of time

Information about a company's cash position is not available.

Information about a company's profitability is not available.

Here is a quick example of why a cash flow statement is more important than an income statement. Berkshire Hathaway reported an operating profit of $24.8B in 2018 but reported lower earnings, i.e., $4.08B. The reason for such a drastic change is related to their investments.

The market value of some of their essential investments went down, reflected in their cash flow statement. 

And investors like Warren Buffet heavily rely on cash flow statements to make significant decisions. An income statement’s inflated figure would look good on paper, but in reality, cash flow decides whether your business stays till next year to generate one or not.

Two Important Cash Flow Terminologies

  • Cash Flow Analysis

  • Cash Flow Forecasting

What is Cash Flow Analysis?

A financial evaluation technique that lets a company analyze its business performance and financial strength. You’ll be able to get a bigger picture of where your cash is coming in and where it is going out! Through cash flow analysis, you can plan your business operations and activities. 

A company can determine its projection accuracy with the help of a cash flow analysis. Know where you’re spending the most and prioritize accordingly to improve your positive cash flow numbers. At times of taking loans or investing in improving business operations and lastly, for effective budgeting too, you need to analyze your cash flow statement. 

Cash flow analysis with an example:

XYZ Corporation Cash Flow Statement

For the Year Ended December 31, 2022(All amounts in USD)

Cash flow from Operating Activities

Net income
Adjustments to reconcile net income to netcash provided by operating activities:
Depreciation expense 
Amortization of bond premium 
Changes in operating assets and liabilities:
Increase in accounts receivable 
Decrease in inventory 
Increase in accounts payable 
Net cash provided by operating activities 
Cash flow from Investing Activities




Purchase of property, plant and equipment 
Sale of marketable securities 
Net cash used in investing activities 


Cash flow from Financing Activities

Dividend paid 


Net increase in cash 


Beginning cash balance 
Ending cash balance


What is Cash Flow Forecasting?

The process of estimating the flow of cash out and in of business over a given amount of time. A well-made cash flow forecast will help firms to predict their cash positions in the future, earn returns on any cash surpluses in the best way possible, and avoid damaging cash shortages.

A cash flow statement is a priceless record for any company. Only a cash flow statement can show you whether a business possesses adequate liquid cash to invest in assets and pay its dues. However, you can’t predict the performance of a company just by analyzing its cash flow statement. For analyzing long-term trends, you should look at its income statement and balance sheet. A great way to get a comprehensive look at a company’s present performance and future outcomes.