Financials and Cash Flow

How to effectively calculate cash flow — and why

Help avoid a liquidity crisis and plan for growth by carefully projecting and managing your cash flow.

Positive cash flow is crucial because without cash, your business can't pay salaries, rent or mortgage, taxes, or other expenses. However, amidst the daily demands of running your business, it can be easy to overlook the importance of cash flow. By projecting and managing cash flow, you can make sure your business has healthy liquidity and is prepared for future growth.

"It starts with careful consideration of how your business works, from knowing your sales cycle to strategically timing payments to vendors," says Robert Schapira, a Wells Fargo Senior Vice President and Southwest Region Small Business Leader.

"A key to being successful from a financial standpoint is to take the time to step away from today's demands and look ahead to the future," he says. "For a business, that means asking if this is the right time to purchase equipment or hire another employee with extra funds, or save that money for a future bump in the road. Those decisions will help you create a plan that you can stick to when you're making so many decisions in the moment."

Plotting your business' path through cash flow projections

Projecting cash flow may seem simple: You sell X number of products at Y dollars to generate Z dollars of revenue. Yet real-life calculations are rarely that easy.

For example, retail businesses have seasonality components. Weather patterns, holidays, and customers' business cycles can all factor into times of higher and lower sales levels. Furthermore, different goods and services have varying sales cycles — some longer and others shorter — which can affect when revenues are received. Add in discounts, fulfillment requirements, credit terms, transaction fees — and projecting cash flow can quickly become complex.

"Many business owners will say they do things one way because that's the way they've always done it," Schapira says. "Taking time to consider what could happen — both challenges and opportunities for growth that may arise — allow you to develop a plan for consistent and healthy cash flow."

Tips for calculating cash flow

Regardless of your business' offerings, your continued success depends on managing cash flow. "When you don't have cash on hand to pay employees because one vendor demanded an early payment or a large customer won't pay you, it can be more devastating than having to liquidate some inventory," Schapira says. "The penalty is you may lose the trust or commitment of great employees, and that is far more damaging."

You don't need to reinvent the wheel to keep tabs on the money coming in and going out each month. There are several spreadsheet tools, apps, and more to help you forecast and monitor your annual cash flow.

Here are a few tips on how to get started with your cash flow projection:

1. Begin by accounting for your starting funds in the bank. Every month, you should confirm that the money in the bank is the amount you expected to be there. Confirming and double-checking your funds are vital processes to ensure your cash flow follows your schedule.

2. Create a list of expected cash sources for each month. Make sure to include expected payments from customers, money coming from bank loans or lines of cash, and other potential income. It's important to be realistic about your sales forecast and to consider how quickly you will receive payment from your customers; will most of your customers pay you within 30 days?

3. Make a list of expected cash expenditures. Take into account the cost of overheads, employee payroll, debt payments, etc. Outline when your payments are due. For example, do your vendors tend to require payment as soon as their invoice is submitted or do they expect to receive payment 30 days after the date of the invoice.

Don't be over optimistic about your assumptions – be realistic. When you decide on your strategies for business cash flow management, you're setting yourself and your business up for a successful year. For more pointers on keeping up with your business finances, consider these eight tips for cash flow management