What’s Cash-Flow? How can you calculate it and what can you do with it as an entrepreneur?
I’ve had the pleasure of helping a few hundred small business owners (1 – 150 employees) create better results in their business and I’ve seen many times that when small business owners start to see what Cash-Flow is and what it can mean in their business, the lights in their eyes begin to shine. And that they begin to enjoy using it as a management tool to evaluate and steer their business.
What Cash-Flow, in practice?
When people talk about ‘cash flow’ and they don’t say whether they are talking about ‘operational cash flow’ or ‘investment cash flow’, or ‘financing cash flow’, they are normally always talking about ‘operational cash flow’. You can also call it ‘cash flow from operating activities’. A very important cash flow for today’s entrepreneurs.
Explaining the heated discussion
There are two main different approaches to ‘operational cash flow’. One says that cash flow is just the difference between the money that enters the company and the money that leaves the company. This seems logical, right? Yes, it does. But there are a few problems with this.
1) If you calculate the cash flow of your last financial year, and you want to see if you’ve done well, it’s hard to compare with your competitors. You need internal information to calculate this form of cash flow exactly.
2) As an entrepreneur, we are always busy creating future business results. We want to work with objectives and see how we have done in a certain period of time. Right? Now, if at the end of a financial year you have carried out and invoiced important works, but they have not yet been paid for, they will not be included in that first cash flow definition (because the money has not yet been received). If that customer happens to pay that big invoice just the first day of your new financial year, or the last day of your old financial year, this makes a big difference in your cash flow according to that first definition. So you are a bit dependent on coincidence, or call it arbitrariness of the customer. The same goes for important orders that you’ve already received, but that you haven’t paid yet, or on the contrary have paid at the end of your accounting year. A few days difference can mean a world of difference in your cash flow.
As an entrepreneur, I find it more valuable to know what all the actions of a year (or another period) have yielded or will yield in terms of cash flow. But only on the basis of the actions you have done. That is interesting. Honor to whom honor is due, honor to the year (or another period) in which you did the work for it. For me, this approach is more important. And we don’t depend on ‘coincidence’ whether the client pays just one day earlier or later.
This second approach (also has drawbacks but) is the one we use here. Because it works better for ‘managers’ who want to create (and measure) results. You can also use it more easily as an objective towards your employees. We often call this approach to calculating operational cash flow the ‘banker’s cash flow’ because bankers also often use this simple way of calculating cash flow.