As a business owner, profit is a priority, but so is keeping your business running through cash flow. Cash flow dictates whether you can pay your wages, BAS, suppliers, and the ATO on time. Thatโs why your cash flow statement is just as important as your income statement and balance sheet: theyโre the primary financial statements that matter most.
Cash flow is broken down into three components: operating, investing, and financing activities. These different types of cash flow help you better manage your companyโs financial health and spot future challenges and operating pressures.
How cash flow is different from profit
Under accrual accounting principles, your income statement keeps a record of sales revenue and operating expenses whenever theyโre earned or incurred โ not when cash payments actually leave or hit your bank account. What that means is that net income (or net profit) can look strong even while your cash balance is under pressure.
Cash flow refers to real-world cash transactions over a given period:
- Cash inflow: Cash and cash equivalents received like card payments, bank transfers, accounts receivable, etc.
- Cash outflows: Cash paid like as supplier bills, accounts payable, wages, tax, and loan repayments.
The cash flow statement shows the net cash flow โ the difference between cash inflows and outflows โ across your core business operations, investing activities, and financing activities. It tells you whether you have more cash coming in than going out, and whether you are at risk of having potential cash shortages, even if your business looks profitable on paper.
1. Cash flow from operating activities
Cash flow from operating activities is where youโll find cash receipts from customers and cash payments to suppliers, staff, and the tax office. It takes your net income figure from the profit and loss and adjusts it for non-cash items and changes in working capital โ things like any movement in accounts receivable/payable and inventory.
- In practice, operating cash flow will encompass things like:
- Cash received from customers for goods and services.
- Cash paid for stock, wages, super, rent, and regular operating expenses.
- Some interest income and interest payments.
If business is running smoothly, youโd expect cash flow analysis to show that operating cash inflows regularly outpace outflows. Consistent positive cash flow from operating activities is a great sign for your businessโs financial health โ it means you can pay expenses and meet all your financial obligations from trading alone.
On the other hand, an income statement may look fine on paper, but if operating cash flow is weak, it may indicate slow-paying customers or cost blowouts. These are red flags that arenโt reflected in a profit and loss statement, which can lead to a weaker financial position.
2. Cash flow from investing activities
Investing cash flow shows changes in your companyโs assets. In it, youโll see how much cash youโre putting into or pulling out of long-term investments that support ongoing business growth.
As a small business, this might include capital expenditures like buying new equipment, vehicles, fit-outs, or technology, or getting cash from selling an asset. It might also include business acquisitions or other investing activities like term deposits and investment properties.
Be prepared that this section usually shows negative cash flow, especially when youโre reinvesting heavily. This isnโt necessarily a problem, as it means your cash flow is being used to generate future profit by building capacity today.
Comparing investing cash flows with cash generated by operations can give valuable insights into whether youโre investing at a sustainable pace or stretching your financial health too thin. It also feeds into your cash flow forecast and longer-term financial strategies, as larger asset purchases can affect future cash flows.
3. Cash flow from financing activities
Financing cash flow tracks how you raise and repay money from lenders and owners. Common items here include new loans, loan repayments, owner drawings, capital injections, dividend payments, and paying dividends to shareholders. Some businesses also show interest payments as financing cash flows.
Positive financing cash flow, for the most part, means more money comes in from external sources (e.g., a new bank facility or capital from investors). Negative financing cash flow might mean youโre making cash payments to bring down debt.
Combining this with your operating cash flow and investing cash flow gives a full picture of how your business is funded, whether cash exceeds outflows overall, and how sustainable your current setup is.
Free cash flow and why it matters
Plenty of advisors will tell you to focus on free cash flow โ calculated as operating cash flow minus any capital expenditures. Free cash flow tells you how much net cash is left after youโve run the business and funded the assets you need.
Consistent positive net cash flow and a free cash flow position mean you have some breathing room to minimise debts and build up your reserves. If free cash flow is consistently negative, you might need to revisit your pricing structure and spending before the business faces serious financial strain.
Using cash flow for better planning and management
Understanding how these cash flows work for your business can help steer your finances in the right direction. Using dedicated accounting software can assist you with regular financial analysis of your cash flow. It can highlight timing issues rather than just profitability problems, giving you better insight into cash flow management.
From there, you can create a cash flow forecast for things like planning for tax or managing your working capital. By keeping track of cash receipts, cash outflows, tax payments, and loan schedules, plus sales, and cost assumptions, you can figure out how much cash you have on hand month to month.
You can use your cash flow statement alongside the income statement and balance sheet. While the income statement shows your profit and loss, the balance sheet shows what you own or owe, and the cash flow statement shows the money flowing into and out of your business. Get them all together, and you have a much more rounded view of your businessโs financial health.
