Understanding cash flow

As a small business, you’ll see that the number in your bank account is fluid – sometimes there’s more money than at other times. This is the basis of cash flow. “What is cash flow?” you ask. Read on see a cash flow formula, learn how to build a cash flow statement, and answer the question, “What is free cash flow?”

Cash flow, in simple terms, refers to the movement of money into and out of your small business bank account over a specific time frame. It is a crucial business metric that represents the actual money generated or expended. This in turn measures the liquidity of a business.

Cash flow vs. profit: What’s the difference?

a small business owner wondering, "what is cash flow" and learning about it with an invoice

People often mix these two terms up. While both are financial concepts, they aren’t the same thing.

Put simply, profit indicates the amount of money left over after expenses are paid. It measures a business’s overall financial success and can be found using a P&L statement (sometimes called an income statement). Profit is the amount of money that is left after a company pays its obligations. Small business owners generally create profit statements at the end of a business year.

In contrast, cash flow shows the movement of money into and out of your company.

Types of cash flow

There are three common types of capital flow you may encounter in your business: operating, investing, and financing.


This reveals if your company has enough money to run. It shows if your business can pay bills and cover operating costs. In short, it tracks money coming in and going out from ordinary business operations. This may include money moving from customer payments, employee salaries, or other expenses.


This represents the movement of funds from the sale of long-term asset investments. This could include things like fixed and speculative assets, securities, property, or business equipment.


This reports the inflow or outflow of money sourced from creditors or investors. It includes transactions involving equity or debt (loans), as well as other things like dividend payments.

What is free cash flow & why is it important?

Free cash flow is another term within the topic of cash flow management. Essentially, it’s a metric found with a simple cash flow formula that looks at how easily your business can access cold hard money. It’s calculated by finding the amount of money in your company accounts after paying operating expenses and capital expenditures. Free cash flow is an important metric investors look at during business valuations and is helpful to understand for cash flow forecasting purposes.

Here is the cash flow formula to use to find your company’s free cash flow value:

Free Cash Flow = Operating Cash Flow – Expenses

Is balancing your small business books stressful?

Get bookkeeping for up to 50% less.

Positive vs. negative cash flow: How it impacts your business

Money comes and goes in a business, depending on your profits and expenses. The movement of money (and its direction) is referred to as positive and negative cash flow. That’s right, flow can change in both the short- and long-term. Plus, it can be tracked and projected using cash flow forecasting.

Positive cash flow

This occurs when incoming money exceeds outgoing funds. Simply put, when your business receives more money than it is spending, you have “positive” flow.

How positive flow impacts your business

Your earnings grow when your business has long-term positive capital movement. To keep your business cash-positive in the long run, you should keep close tabs on where your cash is spent and saved, and ways you can get more of it if needed.

When your business has positive flow, it can meet financial obligations and generate profit. It also opens new opportunities to invest money back into the company to support growth, expansion, and hiring, if desired.

Negative cash flow

This happens when outgoing money outweighs incoming funds. Fundamentally, it is what happens when your business spends more cash than it earns. Low sales and high expenses can contribute to “negative” flow.

How negative flow impacts your business

Depending on the situation, having negative flow in the short term isn’t necessarily bad. Let’s consider two scenarios where short-term negative capital movement may not be a cause for concern:

  1. Your business is new. Initial business set-up, marketing and promotion, research, equipment or furniture, consultancy fees, and other startup expenses can add up when you are starting a new business. On the flip side, if your business is established and still flow negative, it could be a sign that you need to reevaluate your business spending decisions or revenue structure.
  2. You are expanding your business. If you decide to grow your operations, hire new employees or contractors, expand into a larger office, or increase your service or product offerings, guess what? That all costs money. For this reason, you might see short-term negative flow during a business expansion with high money outflow.

The common point in both examples above is that the negative flow is (hopefully) temporary and eventually grows your long-term profits. However, if the trend continues, beware. Long-term negative capital movement should generally be seen as a red flag. Constantly bleeding cash causes financial strain and could even lead to you losing your business. For this reason, it’s essential to implement strategic cash flow management strategies to prevent long-term negative flow.

The importance of cash flow management strategies

Good cash management strategies will keep your business in tip-top shape. Looking for tips to manage and improve this aspect of your business? Start with these strategies:

  1. Control expenses: Take a hard look at your business expenses and cut non-essentials where you can.
  2. Accelerate receivables: Get money coming in! Expedite invoice payment from clients or customers. Use discounts to incentivize early payment. Use short payment terms (net 15 or 30 days) to make sure you always have a cash inflow. Also, stay on top of late payments.
  3. Avoid excess stock: If you own a business with physical goods, consider how much inventory you keep on the shelves. Keep an eye out for slow-moving products and think about how product demand may shift over the course of a year or a season.
  4. Diversify revenue streams: Broaden your product or service offerings to lessen the impact of changes in the market economy or customer tastes. Don’t put all your eggs in one basket.
  5. Consider financing: If your business is continuously in the “red”, short-term financing options like a business loan or line of credit could fill the gap and help get the business’ head above water.
  6. Properly forecast: For the most accurate snapshot, get comfortable with cash flow forecasting. (More on this next.)

What is a cash flow statement?

A cash flow analysis inspects the movement of money from activities such as billing and collections, loan payments, and savings contributions. The goal is to assess a company’s liquidity. This analysis is shared in a cash flow statement.

What’s more, a cash flow statement is a type of financial statement that can be used as a tool to inform your business’ future game plan. Do you have the resources to invest in new technologies? Can you afford to hire a new employee? A cash flow analysis can help answer that.

How to read a cash flow analysis

So, how do you build one of these statements? Remember how we talked about the three categories above? Well, a cash flow statement uses these three inputs to understand your business’ accessible funds.

It combines operating activities, investing activities, and financing activities to determine available cash. This cash flow formula is:

Available cash = operating activities + investing activities + financing activities

Does the thought of conducting an analysis using these and other cash flow formulas on your own have you sweating? Let us put your mind at ease. Block Advisors Small Business Bookkeeping Experts can help you save time and money. Our full-service package rates are up to half-off a typical accountant’s rates. 

If you choose the DIY approach, follow these general steps:

  1. Identify the time frame: Define a specific period to analyze. Consider a monthly, quarterly, or annual time frame.
  2. Gather financial statements: Collect the necessary financial statements, including your profit and loss statement, which provides essential financial information you’ll need to consider.
  3. Determine and analyze categories: Assign each portion of your company’s capital movement to one of the three categories: operating, investing, and financing.
  4. Add it up: Find your business’ net cash flow by summing the totals in the operating, investing, and financing categories.
  5. Interpret the results: Analyze the net cash flow and reflect on what it may indicate for your situation. Is it positive or negative? Looking at a short-term or long-term period?
  6. Compare and contrast: To better understand your calculation, evaluate the analysis results with previous periods or benchmarks. What has increased, decreased, or otherwise changed? Is it a result of internal shifts or external forces?

Let a bookkeeping expert help

Empowered by a Block Advisors Bookkeeping expert, you can better understand your options when it comes to how money moves in your company. That means making more informed business decisions for your company today and tomorrow.

Getting help with things like building your cash flow analysis also means less stress and more time for you. So, you can get back to the parts of the business you are most passionate about.

Schedule a free bookkeeping consultation.

Block Advisors by H&R Block Logo


Find tax help in your area.