WellTax Blog

Cash flow definition and meaning

October 31, 2017

Understanding cash flow is fundamental for running a successful business

Specifically, cash flow is the amount of net financial income produced by the company in a year, given by the difference between all the revenues and all the expenses or, simply, the difference between the amount of money entering the business and the amount of money going out.

The cash flow analysis is the backbone that supports the company, so an inaccurate planning and organization of this “tool” may affect the performance of the business causing its failure. Because of its importance for monitoring and analyzing the company’s ability to generate cash flow, also the banks often take into account its value to assess the strength and the financial solvency of the company.

As already mentioned above, cash flow analyzes the difference between cash inflow and cash outflow and, depending on which one is higher, the company will have a positive or a negative cash flow. Costs such as stocks or raw materials, employees, rent, tax and granting payment delays to own customers absorb resources and result in a decrease in the net working capital, affecting the ability to make new investments or distribute profits.  Therefore, business operation management strongly affects the cash flow structure.

It is vital for the company to  carefully plan and organize its activities in order to drive business to a positive cash flow both at the startup stage but also during the maturity of the business.

If the business is in its startup phase, it is advisable to highlight all the expenses (including those supposed) such as incorporation fees, legal and accounting charges, licenses and permits, construction or renovation, lease or purchase of goods, marketing material, supplies, office supplies, furniture, equipment and more.

It is certainly advantageous to quantify the expected monthly cash income by projecting sales in a prudential way, which means to expect  a lower inflow than what it is believed. In case of a business already set up or a business acquisition, it is fruitful to study the sales’ history to see which business changes may be needed.

If organization and planning are a must, attention to cash flow management is essential as it takes into account several strategies to keep the business healthy.

When facing serious cash flow crises, it is mandatory to operate in a way to balance the working capital. This concerns in particular small businesses as they are personally funded by their founder. It is possible to balance the working capital in different ways, such as standardizing payment processes and billing quickly (better if electronically), allowing immediate liquidation from the clients.


Other good practices could be:

  • To carry out customer checks and their solvency:;
  • To ask for advanced payments or to not allow long delays in payments, as well as avoiding granting credit in the event of a missed payment in the past
  • To make separate forecasts for different scenarios, with different levels of non-payment;
  • To schedule tax payments;
  • To decide whether a loan could be useful;
  • To set detailed and precise sales targets. To be sure to have access to emergency cash and keep in touch with own customers to build a good relationship (this increase the chance that they will pay on time).

In conclusion, as you may have realized from the lines above, to build a cash flow forecasting model is crucial in order to understand the performance of the company and to determine its success.



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Alessio Menna

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