Managing money isn’t usually what draws people toward becoming entrepreneurs, but it’s a big part of the game. While learning all the ins and outs of cash flow can be a major time investment, lack of knowledge about managing cash flows is one of the top reasons why many startups fail.

Why is Cash Flow Management Important?

During the startup phase, finances can be very inconsistent, therefore it’s extremely important to understand cash flow. Having a basic cash flow forecast will help you see where you should be spending your money and where to invest.

Cash flow management simply means understanding and keeping track of the inflow and outflow of your startup’s money. As a business owner, you always want more money coming in than going out; unfortunately, for startups, this can be easier said than done. To help maintain positive cash flow, keep a cash flow statement to monitor any changes in money you have on hand.

Why Should You Keep a Cash Flow Statement?

First, you should know the difference between the cash you have readily available and the amount of money you’re owed, also known as your accounts receivable.

When your accounts receivable has a high balance, it means there is a lot of money that people have not paid you, which of course means you can’t spend it. Making a profit on paper and having the cash right in front of you are very different things, so it’s imperative that you always encourage people to pay you back as quickly as possible.

By keeping track of the cash you have on hand, maintaining a positive cash flow will be easier, helping you plan for future expenses more accurately.

How do you calculate cash flow?

Calculating cash flow is pretty simple and consists of three central components: Operating Activities, Investing Activities, and Financing Activities.

Operating Activities

Operating activities are the core activities of your business. These activities are directly related to the product or service you sell. Cash received from the sale of goods or services, receivables from customers, cash interest, and dividends are all considered incoming cash from operations.

Outgoing cash includes any payments you make, employee salaries, taxes, and all other expenses related to your core activities. The difference between the incoming and outgoing cash from operations gives you your operations cash flow.

Financing Activities

This refers to money spent and received from external activities that allow you to raise capital and pay investors. Positive cash flow includes incurring debt, selling stock, and any other cash received as debt or equity. This is confusing because debt is normally viewed as a negative, but when you incur debt, such as taking out a loan, the money is considered an asset to you.

Repaying your debts, paying dividends, and repurchasing stock are considered to be negative cash flows. The difference between the two flows represents the cash flow from financing activities.

Investing Activities

Investment activities involve the purchase of assets that will create future value. Changes in cash due to plant, property, and equipment (PPE), along with changes in capital expenditures are considered investing activities.

Purchasing these assets is a negative cash flow and selling, or divesting, in these assets is considered a positive cash flow. Again, the difference between the positive and negative flows gives you the cash flow from investments.

Once you have calculated the cash flow from all three activities you need to calculate your net cash flow for the period you’re looking at. To do so, add up the final figures from each activity and there you have it!

Operating Activities + Financing Activities + Investing Activities = Net Cash Flow

Net cash flow is the amount of cash you generated or lost over the period. A negative net cash flow isn’t detrimental to your business, and realistically, you will experience periods of negative cash flow when you’re first starting out. A negative cash flow just means there was decline in your cash balance over that period, not that you’re out of money.

Keeping track of your cash flow is integral to keeping your startup afloat. You should set goals for your monthly cash flow to make sure you are spending and saving appropriately.

Learn more about cash flow and how to set appropriate goals in our free ebook: The Ultimate Guide to Accounting For Startups.