There are three major cash flow activities in each business. These consist of Operating, Financing, and Investing. You’ve heard these terms before, but you’re not clear about how they appear in your small business. After all, you don’t have investments, and you’re running your business with credit cards and a small line of credit.
It is true for many, or should I say most small businesses. You still have these three cash flow activities, and as you grow, it will become critical for you to understand what they look like and how they intertwine. There are two methods of reporting cash flow, the direct and indirect methods, yet they both have the same three cash flow activities.
Activity #1 - Operating Cash Flow
Operating cash flow is the amount of cash that is generated by doing what you do. It is how much money is generated by making, selling, or providing services or products to your customers.
These are the activities or accounts that you will find on your Income Statement. Add all the cash you received from your customers, and subtract all your expenses for the month.
Activity #2 - Investing Activities
Investing activities are the amount of cash flow generated by your equipment or vehicle purchases or any buildings or property the business owns. These activities are found in the Asset section of your Balance Sheet.
The equipment purchases we refer to here are considered long-term and will be “on-the-books” for several years. For example, a printer would purchase a high-speed digital color printer to produce printed products for its clients.
Activity #3 - Financing Activities
Financing activities are the amount of cash flow affected by increases and decreases to equity. In other words, how much cash flow is affected by paying down debt or securing a loan from an owner or a lending institution? These activities are in the Liability and Equity section of your Balance Sheet. This section increases and decreases can be a little deceiving if you are looking at it from a “good or bad” perspective.
An example of a financing activity is securing a loan from a bank. Your cash flow will increase, and when paying back a loan to a principal, will be a decrease in cash flow.
Looking at the three major cash flow activities, can you spot the transactions in your business that can fit into each of these categories?
- Did you purchase a vehicle this year?
- Have you put money into your business this year?
- Have your customer collections been outpacing your expenses?