Cash Flows in … Cash Flows Out
Before we started our companies, we had to earn income as an employee for someone else. We also had to live within our paycheck-means, or … finance our purchases with Other People’s Money – OPM for short. Credit cards and other finance debt instruments like bank loans may help us buy a car, a house, or other major ticket items. But the price we pay for using OPM is the interest payment. And don’t forget, if you’re late on a payment, there may be additional finance charges involved when using OPM.
Cash Flows…Out
When buying the things you need to operate your company—like labor, tools and equipment, marketing, and so on—the money to pay for these necessities has to come from somewhere.
The ideal way to buy things is from the revenues you collect from customers. It’s easy to understand that your revenues should exceed your operating and administrative expenses.
If you use OPM to make necessary purchases, you’re expected to make payments to cover both the principal and the interest charged for the pleasure of using OPM.
Remember, the only portion of loans and credit cards that is deductible as an expense is the interest charged for the service. The principal portion is not a business expense and therefore not deductible.
Always remember: when pulling out the credit card, you are financing your operations with Other People’s Money—and they expect it back, with interest. It’s best to think of this source of cash as temporary borrowed money. The sooner you pay it back, the fewer interest payments you’ll have to make.
NOTE: It’s a good idea to get used to seeing credit card and loan principal as one form of cash for operating your business. The only difference is the source of the money.One source: payments from your customers for services rendered or products delivered. Then there may be the OPM you use to pay bills. Credit cards do not put money into your bank account like a loan might. So think of a credit card purchase as a Delayed Cash Outflow from your business. You will have to pay it back to the credit card company soon enough.
And even though a bank loan may increase your bank account, the principal and interest must be paid back. So think of a bank loan as Temporary Cash Inflow that will become a Cash Outflow when making repayment.
You only see the payment of the business expense from the credit card bank statement. We can classify and assign the expense in your company’s Profit & Loss statement. Remember, the transaction is not going from your checking account to the vendor payment. It is going from OPM bank to your vendor. And the OPM bank tracks this use carefully.
Using OPM does not increase your bank account. This cash flow transaction goes from the credit card company cash to your vendor for payment of your operating expense.
Loans on the other hand may go into your bank account to use to pay operating expense. But remember, it’s a loan of OPM.
Revenues earned from customers = no interest payments. Loans and Credit Cards = interest payments/expense.
Notice Loans and Investments in the Cash Inflows side. Think Family investments, bank loans, and credit cards.
Watch Your Cash Flows Carefully
In and out through sales, investments, payouts and dividends, and purchases and expenses. Your goal should be to generate more cash coming in than going out, of course. I hope you think of all the expenses we categorize and track in the bookkeeping process as the cash flowing out of the business—or Cash Outflows.
You purchase labor—including the required payroll taxes and insurance—so you can accomplish the services you’re selling to your clients. You purchase trucks and vehicles to carry on your trade. These physical things are usually accounted for as assets, but it’s important to remember that they require cash to purchase, maintain, and eventually replace when they’re used up.
How Operating Income Relates to Cash Flow
Operating Income (also called Operating Profit) is:
- The profit your business makes from its core operations.
- Calculated as:
Revenue – Operating Expenses (like labor, rent, marketing, etc.) - It does not include interest payments, taxes, or loan principal repayments.
Cash Flow, on the other hand, tracks:
- The actual movement of cash in and out of your business.
- Includes things like:
- Loan proceeds (cash in)
- Loan repayments (cash out)
- Equipment purchases (cash out)
- Customer payments (cash in)
- Credit card payments (cash out)
Cash is King!
More coming in than going out is a critical step toward successfully operating a business. Here is a table comparing your company’s Operating Income to your Company’s Cash Flow…to illustrate that looking good on paper may not mean you have the cash to cover expenses:
| Concept | Operating Income | Cash Flow |
|---|---|---|
| Focus | Profitability from operations | Liquidity and timing of cash |
| Includes | Revenue minus operating expenses | All cash transactions (including financing and investing) |
| Excludes | Loan payments, asset purchases, taxes | Non-cash expenses like depreciation |
| Connection | Positive operating income usually leads to positive cash flow from operations | Cash flow can still be negative if money is tied up in inventory, receivables, or debt payments |
For example, if you are not collecting payments from your clients and they are late on payments, your Balance Sheet Accounts Receivables might look good, but your bank account may not. In other words, Cash Flow means that the keyword, Cash, is both coming in and available to pay out.
Article Use Disclaimer
This blog post is for informational purposes only and does not constitute legal, financial, or professional advice. Use at your discretion and always check with appropriate experts. [Read full disclaimer here].
Thank you for reading.
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