What are the 3 sources of cash of a company and describe them?

Business owners can't very well manage what they can't measure. Better cash-flow management begins with measuring business cash flow by looking at three major sources of cash: operations, investing and financing.

These three sources correspond to major sections in a company's cash-flow statement as described by a Securities and Exchange Commission guide to financial statements.

Together with the income statement and balance sheet, the cash-flow statement is a basic document for understanding a business's financial condition.

A cash-flow statement shows changes in cash over time. Business owners use it to determine whether they will be able to pay upcoming bills such as wages and rent. Lenders look at business cash flow to decide whether to make a loan.

Businesses with strong cash flow from operations are able to more easily access financing. And the better and stronger their operations are, the lower the cost of the financing that they can get.

—Evan Singer, CEO, SmartBiz

Understanding these three sources of business cash flow can help business owners create an accurate and informative cash-flow statement.

“Cash flow is generated from operations, from investments in fixed assets and from financing activities," says Laurie Jamison, senior treasury services officer for Allegacy, a credit union headquartered in Winston-Salem, North Carolina. “Cash flow is the lifeblood of the business and should be the primary focus as it reveals the health of the business."

Cash From Operations

Cash from operations consists of cash collected from sales revenue after payments for costs of goods, taxes, interest on loans and other expenses are subtracted. It is not the same as income or profit.

A business's income statement may show a profit, but if payments from customers lag behind payments to suppliers and other costs, a business may run out of cash.

Non-cash outlays such as depreciation that are subtracted from revenue on the income statement are added back when calculating cash flow from operations on the cash-flow statement. Changes in inventory, accounts receivable and accounts payable also affect cash flow from operations.

Decreases in inventory and accounts receivables increase business cash flow and vice versa. With payables, it's the opposite. Higher accounts payable mean more cash, while reductions reduce cash.

Lenders deciding whether to extend credit to a business focus on cash flow from operations, according to Evan Singer, CEO of SmartBiz, a San Francisco-based online bank marketplace for loans guaranteed by the Small Business Administration.

Lenders specifically want to see if a business has enough cash flow to cover payments on a loan, Singer says.

“The businesses with strong cash flow from operations are able to more easily access financing," Singer says. “And the better and stronger their operations are, the lower the cost of the financing that they can get."

Cash From Investing

Cash from investing shows cash raised by selling business assets. These may include excess or obsolete equipment, real estate or investment securities.

Cash spent to buy equipment, real estate or other assets appears as a cash outflow in this section of the company's cash-flow statement.

Investments in less tangible assets, such as building brand recognition or buying intellectual property, may also appear in this section as cash outflows.

“Investing in long-term assets and profiting from the sale of these assets later contributes to cash flow by providing a stable asset that, while not turning a profit directly, is not eating up cash flow either," says Alex Shvarts, chief technical officer of FundKite, a New York City-based alternative business lender.

Cash From Finances

Cash from financing for most businesses consists of cash received from loans and drawing down credit lines.

Financing cash may also be raised by selling stock or ownership in the company, or by issuing bonds and selling them to investors.

Principal payments that reduce the balance on a bank loan, property mortgage or line of credit are included here as outflows of cash from financing. So are any dividends paid to owners of the company.

Owners can increase business cash flow from financing by obtaining new loans, or by refinancing existing loans, notes Singer.

“They could refinance some existing debt with a high monthly payment to a loan with a lower monthly payment and that would improve their cash flow," he explains.

Business Cash Flow Caveats

These are typical sources of cash for most businesses, but they're not equally important for all businesses. For instance, young businesses may generate little cash from operations at first. They may sustain themselves on cash from financing or equity investments until they reach profitability.

For older businesses, robust cash generated by operations is considered a marker of a healthy business. A business that is surviving by selling off assets may appear more risky.

Other sources of cash may be important from time to time. These could include proceeds from a lawsuit settlement or insurance claim.

Also, Singer notes that some lenders of SBA-backed loans combine a company's cash-flow statements with the owners' personal cash-flow statements when making lending decisions.

“Our banks will look at both of those two ways to calculate cash flow," he says.

Business owners who want to feel comfortable about paying bills or getting a loan can improve their cash-flow statement by working on any of these areas.

Read more articles on managing money.

Photo: Getty Images

The information contained herein is for generalized informational and educational purposes only and does not constitute investment, financial, tax, legal or other professional advice on any subject matter. THIS IS NOT A SUBSTITUTE FOR PROFESSIONAL BUSINESS ADVICE. Therefore, seek such advice in connection with any specific situation, as necessary. The views and opinions of third parties expressed herein represent the opinion of the author, speaker or participant (as the case may be) and do not necessarily represent the views, opinions and/or judgments of American Express Company or any of its affiliates, subsidiaries or divisions. American Express makes no representation as to, and is not responsible for, the accuracy, timeliness, completeness or reliability of any such opinion, advice or statement made herein.

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