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Understanding How Cash Flow Works

In its simplest form, cash flow is the movement of money in and out of your business. It could be described as the process in which your business uses cash to generate goods or services for the sale to your customers, collects the cash from the sales, and then completes this cycle all over again.

Inflows. Inflows are the movement of money into your cash flow. Inflows are most likely from the sale of your goods or services to your customers. If you extend credit to your customers and allow them to charge the sale of the goods or services to their account, then an inflow occurs as you collect on the customers' accounts. The proceeds from a bank loan is also a cash inflow.

Outflows. Outflows are the movement of money out of your business. Outflows are generally the result of paying expenses. If your business involves reselling goods, then your largest outflow is most likely to be for the purchase of retail inventory. A manufacturing business's largest outflows will mostly likely be for the purchases of raw materials and other components needed for the manufacturing of the final product. Purchasing fixed assets, paying back loans, and paying accounts payable are also cash outflows.

It is important to manage your cash flow because:

  • Smart cash flow management is vital to the health of your business. Hopefully, each time through the cycle, a little more money is put back into the cash flow cycle than flows out.
  • Our case study illustrates what can happen to your business if you don't carefully monitor your cash flow, and take corrective action when necessary.
  • Your profit is not the same as your cash flow. It's possible to show a healthy profit at the end of the year, and yet face a significant money squeeze at various points during the year.