Cash flow is an important economic measure of how a company is doing. In short, it is the amount of money flowing into and out of a company, and it is a key indicator of a company’s liquidity.
Cash Flow vs. Net Income
Though they may seem similar, there is an important distinction between cash flow and net income, as explained by writer Carol Wiley at Chron.com. One difference is that net income is determined by subtracting expenses from total revenue.
Another difference is that while income is recorded at the time of a transaction, a company may not receive the cash from that transaction for some time. For instance, if a company delivers a service at a cost of $500 to the company and receives $1,500 in payment 30 days later, then the company would record an immediate net income of $1,000, but no actual incoming cash until the payment arrives 30 days later. In the meantime, the company will still have sent out $500, making for a temporarily negative measure.
Issues with Incoming Cash
Insufficient cash flow be a significant hurdle for a company to overcome. For example, meeting operating expenses may be difficult if there is not enough money coming in. Additionally, lenders and investors often look at this metric as an indicator of a company’s health. However, there are several strategies a company can use to improve its flow of cash, as highlighted by Investopedia’s Dan Moskowitz. Those strategies include:
- Leasing rather than buying equipment in order to keep payments small.
- Offering early payment discounts to encourage clients and customers to pay promptly.
- Doing your best to get rid of slow-moving inventory, even if it needs to be discounted.
- Negotiating advantageous deals with suppliers.
- Experimenting with higher pricing to find out exactly how much clients and customers are willing to pay.
That covers the basics of the topic of cash flow. For coverage of other financial topics, take a look at the rest of Pendleton Commercial Financing’s blog posts.