Cash Flow 101

Cash, Investing & Retiring

Cash flow sounds like a relatively simple concept, and in some ways it is, but poor cash flow management can take down a small business. Cash flow is equally critical for households. If you miss a paycheck when bills come due and you have no reserve funds available, you will incur losses in terms of late payment fees and other potential penalties.

How do you manage cash flow? First, you have to track it properly. Businesses do so with a cash flow statement (CFS) and homes by means of a household budget.

For businesses, a CFS covers the flow of cash in and out over a particular period of time. Start with net earnings, which is the cash from revenue minus expenses (cost of goods sold, taxes, etc.). From there, adjustments are made based on other flows of cash in and out from operations, investing activities, and financing activities.

Examples of adjustments include the following:

  • Accounts Receivable/Payable – An increase in Accounts Receivable decreases cash flow —essentially, you have extended more credit to people who owe you money. A decrease in Accounts Receivable means more dollars have been received as cash than extended as credit, and thus a positive cash flow results.

    Accounts Payable works in the exact opposite fashion. An increase in Accounts Payable means you have increased your own credit and paid out less cash; a decrease in Accounts Payable means that you have paid out more in cash and taken less on credit. If you want more credit, check out MoneyTips’ list of credit card offers.

  • Inventory – Increases in inventory make cash flow negative (since you “paid” money to produce that extra inventory). Decreases in inventory will show up as positive income, assuming they were sold and not scrapped.
  • Depreciation – Depreciation does not involve cash, but it does change the cost of an item to partial expenses over time. That cost adjustment decreases net income, and thus it must be added back to the cash flow statement as a depreciation expense (positive to cash flow).
  • Investments – Cash flow is adjusted downward when investing in items that you need to maintain and improve your business.
  • Financing – This could be positive or negative. Paying out dividends is an example of negative cash flow, while issuing bonds would result in positive cash flow.

Sum up all the positive and negative flows, and that captures the cash flow for your business.

With a home, cash flow is captured within a budget. Generally, budgets are weekly or monthly, but they must take into account annual expenses like insurance payments or annual renewal subscriptions. Lay out all of your revenue (salary, etc.) and your expenses (monthly bills, etc.), and add contingency cash for unexpected expenses like auto repair.

Home cash flow does not usually cover depreciation and investing in an accounting sense, but it does in a budgeting sense. If you know that you have to replace your car in a particular year, it must end up as an item to consider in that year’s expense budget.

In both home and business applications of cash flow, proper tracking is a must. Timing and anticipation of revenue and expenses then takes priority. Monitor your home cash flow and treat it as an accountant would. If you cannot account for all of your incoming cash, at least you know that you have a problem.

Typically, this leads to a realization that the little things like buying a few extra coffees, eating out more often, and daily snacks add up and take a toll on your cash flow. What you do with that cash flow analysis is up to you.

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