Cash is the lifeblood of a business. A business owner gets cash from every day activities (operations), financing or investing. Cash flow from operations should be the most significant source of cash in a business. However, a business striving for growth would often get financing to fund this growth. Let us take a look at the three main sources of cash below:
Cash flow from operations
Cash flow from operations comes from the sale of goods and services in your business. Cash flow from operations is all the money that flows in and out for daily operations. This is the most important source of cash in the cash flow statement. The cash flow from operations should be sufficient to fund the business normal operations with enough left over for further investments or distributions to owners.
Investments in your business
Cash flow from investments includes cash flows from changes in investments and long term assets. Buying long term assets in your business is an investment in your business. Assets have to be created and maintained to grow. Some assets are held for the income producing value and some are held to appreciate. Not all assets are investments. Investments is money put forth to bring back more. In business, you want good investment assets. A good investment is one whose net present value exceeds the required rate of return. Before investing in an asset, you should analyze the return to estimate whether or not you have a good investment.
Cash flow from financing
Investments are often financed through external sources such as lenders or equity investors. A lender lends you money and you pay the money back over a period of time with interest. Unlike personal loans, I am not against business loans, as long as you can borrow money at a lower rate and then invest it for a higher return. Financing activities can also be used to finance the purchase of inventory. Payments for loans usually come from cash from operations. This is because financing activities are usually used to finance investments that result in more cash flow from operations. Cash from operations should be more than sufficient to pay back loans plus the interest.
In summary, cash is the lifeblood of a business. Understanding the sources and timing of cash is vital. This is why preparing cash flow projections is very essential because you want to know where you have short fall in cash. If a short fall is determined then you need to figure out how to fill the gap. You can choose to sell an asset which will be cash inflow from investment or get a loan or use personal funds which will be cash inflow from financing.