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.
This 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 method and the indirect method yet they both have the same three cash flow activities.
Cash Flow Activity #1 – Operating Cash Flow
This is the amount of cash that is generated by doing what you do. This is how much cash 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.
Cash Flow Activity #2 – Investing Activities
This is 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 are referring 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 that she uses to produce printed products for her clients.
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Cash Flow Activity #3 – Financing Activities
This is 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 found in the Liability and Equity section of your Balance Sheet. In this section, increases and decreases can be a little deceiving if you are looking at it from a “good or bad” perspective.
An example would be securing a loan from a bank which can be perceived as an increase in cash flow (cash flow provided by financing activities) and paying back a loan to a principal which can be perceived as a decrease in cash flow (cash flow used for financing activities).
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? Has your customer collections been outpacing your expenses?