The Types of Cash Flow Explained: Operating, Investing and Financing

Understanding the types of cash flow is one of the most useful money skills there is, whether you run a business, invest in shares or just manage your own bills. After all, profit can look great on paper while the bank account runs dry. In this guide I explain the three main types of cash flow, what free cash flow means and how to use cash flow in your own finances.

What Is Cash Flow?

Cash flow is simply the money moving in and out of a business or household over a period of time. In short, money coming in is a cash inflow, and money going out is a cash outflow. The difference between them is your net cash flow.

Cash flow is different from profit. For example, a business can make a profit but still run out of cash if customers pay late. That is exactly why so many profitable small businesses fail. Cash, not profit, pays the bills.

The 3 Main Types of Cash Flow

Company accounts split cash flow into three types. Together, they make up the cash flow statement, one of the three key financial statements alongside the income statement and the balance sheet.

Type of cash flow	What it covers	Examples
Operating	Day to day trading	Sales receipts, wages, suppliers, tax
Investing	Buying and selling long term assets	Equipment, property, buying another company
Financing	Money from or to lenders and owners	Loans, repayments, new shares, dividends

Operating Cash Flow

This is the cash generated by the business itself. In fact, it is the most important of the three types of cash flow, because it shows whether the core business brings in more cash than it spends. A healthy company has strong, positive operating cash flow year after year.

Investing Cash Flow

This covers spending on long term assets like machinery, vans, buildings and software, plus any money from selling them. As a result, it is usually negative for a growing business, and that is often a good sign, as it means the company is investing in its future.

Financing Cash Flow

This shows money raised from or returned to lenders and shareholders. For instance, taking out a loan or issuing shares brings cash in. Repaying debt, buying back shares and paying dividends send it out.

What Is Free Cash Flow?

Free cash flow is operating cash flow minus the money spent on equipment and other long term assets. In other words, it is the cash left over that a company can use to pay dividends, buy back shares, pay down debt or grow.

Investors love free cash flow because it is harder to dress up than profit. So if you are choosing dividend stocks, check that free cash flow comfortably covers the dividend. If it does not, the payout may be at risk.

Cash Flow for Small Businesses

For a small business or sole trader, cash flow is a matter of survival. Fortunately, a few practical habits make a big difference.

Step 1: Forecast the Next 13 Weeks

List the cash you expect in and out each week. This way, it shows tight spots weeks before they happen, giving you time to act.

Step 2: Get Paid Faster

First, invoice straight away, ask for deposits on big jobs and chase late payers politely but firmly.

Step 3: Put Tax Money Aside

VAT, income tax and corporation tax bills can be a nasty shock. Therefore, moving a set percentage of every payment into a separate account means the money is there when HMRC wants it. Our guide to small business finance tips covers more.

Your Personal Cash Flow

The same ideas work at home. Your take home pay is your operating cash inflow, and bills and spending are outflows. Positive cash flow each month is what lets you save, invest and clear debt.

Over time, the goal is to build investments that create their own cash flow, such as dividends, interest and rent. Also, our guide on how to invest for income shows how to get started.

Related reading: Traits of Successful Entrepreneurs.

Why the Types of Cash Flow Matter

Knowing the types of cash flow helps you judge a business properly, run your own company with fewer shocks and manage your household money better. In particular, look for strong operating cash flow, sensible investment and financing that is not propping everything up.

If you get those right, the profits usually take care of themselves.

Can a Profitable Business Run Out of Cash?

Yes, and it happens more often than you might think. A business can make a profit on paper while waiting months for customers to pay, so it cannot cover its own bills. That is why cash flow forecasts matter so much.

What Is Negative Cash Flow?

It means more money is going out than coming in over a period. A short spell is not always a problem, for example when a business invests in growth, but ongoing negative cash flow needs fixing fast.

Content on IceburgWealth.com is for general information only and is not financial advice. I am not a regulated financial adviser, and tax rules and figures can change. Always do your own research and consider speaking to a qualified adviser before making any financial decision.

This article is part of our Small Business Guide, where you will find every related article in one place.

Types of Cash Flow: Common Questions

Which type of cash flow matters most?

For most businesses, operating cash flow. It shows whether the day to day business actually brings in more cash than it spends.

What is free cash flow?

It’s operating cash flow minus spending on things like equipment and buildings. It’s the cash left over to pay debts, dividends or reinvest.

How does this apply to my personal finances?

The same idea works at home. Your income in, minus bills and spending out, is your personal cash flow. Read how to track your expenses.

Disclaimer: This article is for general information only and is not financial advice. I'm not a regulated financial adviser. Rules, rates and allowances can change, so check the latest details and speak to a qualified professional before making any decisions.