What is cash flow management?

Cash flow management means tracking how much money is coming into and going out of a business or household. It is an important part of budgeting and ensuring there is always enough money to pay bills and expenses.

Money comes in and goes out

Money comes into a business or household in a few main ways:

Getting paid for work
Selling things
Getting loans
Receiving gifts

Money goes out to pay for things the business or household needs:

Buying supplies and inventory
Paying employees
Paying for rent, utilities, and other bills
Buying equipment
Paying back loans

The money coming in is called “inflow” and the money going out is called “outflow”. Cash flow management means understanding and controlling the timing and amounts of the inflows and outflows.

Positive vs negative cash flow

The goal is to have more money coming in than going out. This is called “positive cash flow”. When a business or household spends more money than it earns, this is “negative cash flow”.

Negative cash flow is a problem because it means running out of money to pay bills. The business or household needs to either increase inflows (earn more money), decrease outflows (spend less money), or borrow money to cover the gap.

The role of cash flow in budgeting

Cash flow management plays a key role in the budgeting process. A budget is a plan for how money will be earned and spent over a period of time, like a month or a year.

Knowing inflows and outflows

To create a budget, the business or household first needs to know how much money is coming in and going out each month. This means tracking all the different inflows and outflows.

Inflows to track include:

Paychecks from jobs
Income from selling products or services
Interest and investment income
Any other money received

Outflows to track include:

Rent or mortgage payments
Utility bills like electricity, water, internet
Car payments and transportation costs
Food and grocery expenses
Insurance premiums
Debt payments
Entertainment and discretionary spending
Any other bills and expenses

Gathering records of the inflows and outflows, like bank statements, bills, and receipts, helps create a clear picture of the monthly cash flow situation.

Creating the budget

With the cash flow information, the next step is to make a budget. The budget should include:

The expected monthly inflows (income)
The expected monthly outflows (expenses)
Some room for unexpected expenses or emergencies (an “emergency fund”)
Financial goals, like paying off debt or saving for big purchases

If the total expected monthly outflows are bigger than the inflows, the budget has a negative cash flow and needs to be adjusted. This could mean:

Increasing income by getting another job or raising prices
Cutting back on optional expenses
Finding ways to reduce required expenses, like using less electricity or finding a cheaper phone plan

The budget should be balanced, with the inflows matching or exceeding the outflows. Any extra money left over can be put towards the emergency fund or financial goals.

Tracking progress and making adjustments

Cash flow management continues after the budget is made. The business or household needs to track the actual inflows and outflows and compare them to the budget throughout the month.

If actual inflows are lower than expected or actual outflows are higher, it can throw off the budget and cause cash flow problems. Catching these issues early makes them easier to fix.

For example, if halfway through the month the household notices they have already spent their entire food budget, they need to cut back on food spending for the rest of the month to avoid going over budget. Or if a business has a slow month and earns less revenue than expected, they may need to tap into their emergency fund to cover expenses.

Regularly checking the actual cash flow against the budgeted cash flow allows for quick changes and adjustments to stay on track. The budget is not set in stone and can be updated each month as needed.

The importance of cash flow management

Cash flow management is critical to the financial success and stability of any business or household. It allows for:

Avoiding debt and financial problems

Good cash flow management decreases the risk of running out of money and going into debt. By ensuring there is always enough cash to cover expenses, businesses and households can operate without taking on costly debt like credit card balances or payday loans.

When cash flow problems do happen, having an emergency fund provides a buffer and decreases the need for debt. Regularly budgeting and planning for big expenses also prevents the need to scramble for loans or financing.

Making informed financial decisions

Knowing the cash flow situation allows businesses and households to make better financial decisions. Because they have a clear picture of how much money is available, they can decide whether they can afford big purchases and expenses.

For example, a business owner who knows she has strong positive cash flow can be more confident in her decision to buy new equipment or open a new location. A family that budgets for a big vacation can save up the cash over time and enjoy the trip without going into debt.

Understanding cash flow also informs decisions about getting loans and financing when they are needed. For example, a business with stable cash flow is more likely to qualify for good loan terms.

Achieving financial goals

Controlling cash flow is an important part of reaching financial goals. For households, it could mean saving up for a down payment on a house, paying off student loans, or building a retirement fund. For businesses, it could mean expanding to new markets, launching new products, or becoming profitable.

Having a budget and sticking to it allows people to ensure they are consistently putting away money to reach those bigger goals. They can treat their goals like any other “expense” and regularly put a portion of their income towards them.

Staying on top of cash flow also means avoiding overspending and staying focused on the goals. Knowing where the money is going each month keeps people accountable and on track.

Weathering financial ups and downs

Good cash flow management helps businesses and households survive financial rough patches. It ensures they have the savings and plans to survive slow months, economic downturns, and emergency expenses.

With budgeting and cash flow planning, they can build up an emergency fund to cover unexpected outflows. They can also make plans for how to cut back or find additional income in an emergency.

By monitoring their cash situation and being proactive, they are more likely to overcome financial setbacks. Strong cash flow management is like a financial seatbelt—it provides safety and security.