Learn about cash flow basics and how they apply to different types of businesses.
Whether you’re starting, acquiring, or running a business, your company’s cash flow affects operations and growth. Simply defined, cash flow is the amount of money moving in and out of your business. However, it can also be a measure of your business’s health — and can help your banker identify the risks and opportunities that are relevant to your business.
Here’s what you need to know about cash flow, how it differs from other financial metrics, how it affects different types of businesses — and how your banker can help you manage it effectively.
Cash flow basics
What is cash flow? It’s the money received and paid by your business. Positive cash flow, when the business has more money coming in than going out, is essential for smooth operations and meeting day-to-day expenses like payroll, supplies, and other costs. Having adequate cash flow can be especially important during periods of economic uncertainty.
The term “cash flow” is sometimes used interchangeably with other financial metrics — and often those other measures have a different meaning. For example, cash flow is different from:
Revenue: the money earned from selling products and/or services
EBITDA: an acronym for “earnings before interest, taxes, depreciation, and amortization.” EBITDA is a metric that is used to measure profitability, typically in businesses with revenue greater than $5 million annually, although it may also be used in smaller businesses in some cases. It does not measure how cash moves in and out of a business.
Profit: the money left over when the business operating expenses are subtracted from revenue over time. It’s possible for a business to be profitable even with periods of negative net cash flow and vice versa.
Seller’s discretionary earnings (SDE): typically used for small, owner-operated businesses with revenue of less than $5 million annually. SDE measures a company’s income minus expenses. It also includes the owner’s compensation and expenses and does not count them as an expense.
How do you manage cash flow effectively?
Cash flow management starts with calculating your net cash flow, which is what’s left when you subtract your total expenses from the total cash your business earned. This can be done for a specific period of time — monthly, quarterly, annually — depending on your preference or your business needs. To help visualize your total and net cash flow for a period in the future, you can create a cash flow projection.
Once you’ve calculated your net cash flow or completed the cash flow projection, look for red flags. How do cash flow problems usually start? They are periods when the money the business has coming in is less than its expenses.
However, there are also times when the business may have periods of tight cash flow that are part of the business’s normal cycle, such as:
Seasonality. Some businesses — for example, construction companies, snow removal services, winter or summer resorts, and some retailers — earn most or all of their money during specific periods of the year. Cash flow may be robust during these times but lean during others.
Growth periods or big orders. If your business is growing, you may face unexpected costs. For example, let’s say you own a landscaping company that needs to front the cost of materials and labor for a big job before getting paid for the work. Obtaining the right financing is critical and often time-sensitive, so your bank must be responsive and looking out for your business.
Long-term expansion. If your business is planning an expansion — let’s say you’re a dentist and opening an office in a new market —you may need to cover increased expenses before you enjoy the revenue from the new office. A loan or line of credit may be helpful to manage these expenses in the short term while you wait for the return. Other reasons for cash flow issues may be challenges like late customer payments or other income interruptions. Such situations may point to other steps you need to take to bolster your business’s health. A Wells Fargo Business Banker can help you find the right financial tools to match the way your business functions.
Easing cash flow crunches
Gaining insight into your business cash flow is key to helping you stay ahead of cash needs. To do so, there are several steps you can take:
Create a business budget. Whether your company is a fast-growing start-up or an established business, creating a budget is an important part of managing spending. Check out tools like Wells Fargo’s Budget Watch for Business or financial management software like QuickBooks.
Build cash reserves. Within your business budget, earmark some of your revenue for savings to help you create a cash cushion you can use to manage cash ups and downs. Set aside these funds in a separate account to prevent inadvertently spending them.
Expedite receivables. Getting your money in the door sooner can also help improve cash flow. Be sure your team is invoicing promptly and look at options like letting customers pay with Zelle®¹ for your business or applying for a merchant account so your business can accept credit cards for faster payment. Merchant accounts provide next-day funding to your Wells Fargo business checking account and allow you to flexibly accept payment across customer-preferred methods.
Use business debt wisely. Business credit cards, lines of credit, and loans can all be solutions to help you manage cash flow, whether you need to bridge seasonal gaps, short-term outflow to cover inventory and supplies, or invest in long-term growth. A Wells Fargo Business Banker can help you evaluate your credit options.
Talk to a Wells Fargo Business Banker about ideas to simplify the oversight of your finances and identify the tools and options that will help you support your business’s different types of cash flow needs, both now and as the business continues to grow.
