Back in the early 2000s, I was advising a startup that had just raised a substantial Series A round. The founders were brilliant technologists with an innovative product, but when I asked about their cash flow, they gave me a puzzled look. “We have money in the bank,” one said. “Isn’t that all that matters?”
That moment sticks with me because it highlights a common misunderstanding: cash and cash flow are not the same thing. Having money in the bank is important, but understanding where that money comes from, where it goes, and which flows matter most is crucial for long-term success.
If you’re a small business owner, you’ve probably heard that “cash is king.” But which cash flow is really the king of kings? Let’s break it down.
The Three Types of Cash Flow: A Primer
Before we can determine which cash flow is most important, we need to understand the three distinct types:
1. Operating Cash Flow (OCF)
This is the money that flows in and out of your business through normal operations. It includes:
- Cash received from customers
- Cash paid to suppliers
- Employee salaries and wages
- Rent and utilities
- Taxes and other operating expenses
Operating cash flow answers the fundamental question: “Can my business generate cash from its core activities?”
2. Investing Cash Flow (ICF)
This represents cash used for buying or selling long-term assets. It includes:
- Purchasing equipment or machinery
- Buying or selling property
- Acquiring or selling other businesses
- Investments in securities (stocks, bonds)
- Research and development expenses (in some cases)
Investing cash flow answers the question: “How much am I investing in my business’s future?”
3. Financing Cash Flow (FCF)
This tracks money related to funding your business and returning value to investors. It includes:
- Loans taken or repaid
- Equity investments received
- Dividend payments
- Stock buybacks
- Lease payments (in some cases)
Financing cash flow answers the question: “How am I funding my operations and growth?”
These three flows, when combined, give you your net cash flow—the overall increase or decrease in your cash position over a period.
Which Cash Flow is Most Critical for Business Sustainability?
If I had to pick one type of cash flow as most important, it would be Operating Cash Flow. Here’s why:
Operating Cash Flow: The Lifeblood of Your Business
Operating cash flow is the most important for several reasons:
- It’s sustainable. Unlike financing cash flow, which depends on external parties, operating cash flow comes from your core business activities. You can control it more directly.
- It reflects your business model’s viability. Positive operating cash flow indicates that your fundamental business model works—you’re selling products or services for more than it costs to produce and deliver them.
- It funds day-to-day operations. Without positive operating cash flow (or cash reserves), you can’t pay your bills, employees, or vendors.
- It enables organic growth. The best kind of growth is funded by your own operations, not external capital.
- It provides flexibility. When you generate excess operating cash flow, you have options—you can invest in growth, pay down debt, or return value to shareholders.
I’ve seen countless businesses fail despite having impressive revenue numbers because they couldn’t generate positive operating cash flow. One memorable example was a food delivery startup that grew rapidly but lost money on every order. They kept raising capital to fund operations, but eventually, investors lost patience, and the company collapsed.
Positive operating cash flow doesn’t guarantee success, but negative operating cash flow eventually guarantees failure unless something changes.
When Is Investing Cash Flow More Important?
While operating cash flow may be the most critical in general, investing cash flow takes center stage in certain situations:
Growth and Expansion Phases
When your business is in a rapid growth phase, investing cash flow becomes extremely important. This is especially true if you’re:
- Expanding into new markets
- Developing new product lines
- Building new facilities
- Acquiring competitors
During these periods, you might intentionally have negative investing cash flow as you put money into assets that will drive future growth.
Capital-Intensive Industries
In industries that require significant upfront investment in equipment or infrastructure, investing cash flow is often closely watched. Examples include:
- Manufacturing
- Real estate
- Transportation
- Energy
- Telecommunications
A friend who runs a manufacturing business once told me, “I watch my investing cash flow like a hawk. If I invest too little, I fall behind competitors. If I invest too much, I risk overextending.”
Modernization and Efficiency Improvements
When you need to modernize operations or improve efficiency, investing cash flow becomes crucial. This includes:
- Upgrading technology
- Automating processes
- Renovating facilities
- Training employees on new systems
These investments often pay off through improved operating cash flow in the future.
When Is Financing Cash Flow Most Relevant?
Financing cash flow takes priority in specific situations:
Startup Phase
For early-stage businesses, financing cash flow is often the most important. Why? Because many startups aren’t yet generating positive operating cash flow. They rely on:
- Equity investments from founders, friends, family, or venture capitalists
- Loans from banks or alternative lenders
- Grants or subsidies
In this phase, securing adequate financing is literally a matter of survival.
Rapid Expansion
When a business is growing faster than its operating cash flow can support, financing cash flow becomes critical. This might include:
- Getting a line of credit to manage larger inventory needs
- Securing term loans for new equipment
- Raising equity to fund market expansion
Debt Management
For businesses carrying significant debt, monitoring financing cash flow is essential. This includes tracking:
- Principal and interest payments
- Debt covenant compliance
- Refinancing opportunities
- Debt-to-equity ratios
Returning Value to Owners
For mature businesses, financing cash flow often reflects how value is returned to owners through:
- Dividend payments
- Share repurchases
- Partner distributions
How the Importance of Cash Flow Varies by Business Stage
The relative importance of each type of cash flow shifts as your business evolves:
Startup Stage
Priority order:
- Financing Cash Flow
- Operating Cash Flow
- Investing Cash Flow
At this stage, securing funding is paramount. You’re likely investing in assets (negative investing cash flow) and may not yet have positive operating cash flow. Your focus is on extending your runway until you can achieve operational sustainability.
Growth Stage
Priority order:
- Operating Cash Flow
- Investing Cash Flow
- Financing Cash Flow
As your business matures, generating positive operating cash flow becomes increasingly important. You’re still investing heavily in growth, but ideally, those investments are increasingly funded by operations rather than external financing.
Maturity Stage
Priority order:
- Operating Cash Flow
- Financing Cash Flow
- Investing Cash Flow
Mature businesses typically focus on maintaining strong operating cash flow, managing debt efficiently, and returning value to shareholders. Investing cash flow might be less about expansion and more about maintenance and incremental improvements.
Decline or Turnaround Stage
Priority order:
- Operating Cash Flow
- Financing Cash Flow
- Investing Cash Flow
Businesses facing challenges often need to focus intensely on improving operating cash flow while managing debt obligations. Investing activities might be limited to essential maintenance or strategic divestments.
Industry Variations in Cash Flow Importance
The relative importance of different cash flows also varies by industry:
Retail and E-commerce
Key cash flow focus: Operating Cash Flow
Retail businesses need to manage inventory efficiently and ensure strong operating cash flow, especially during seasonal fluctuations. Cash conversion cycles are particularly important in this sector.
Manufacturing
Key cash flow focus: Investing Cash Flow and Operating Cash Flow
Manufacturing businesses often require significant capital investments in equipment and facilities, making investing cash flow critically important. However, they also need strong operating cash flow to fund those investments.
Software and Technology
Key cash flow focus: Operating Cash Flow (for established companies) or Financing Cash Flow (for startups)
Software companies often have high gross margins and low capital requirements once established, making operating cash flow their primary focus. However, early-stage tech companies might prioritize financing cash flow to fund rapid growth.
Real Estate
Key cash flow focus: Investing Cash Flow and Financing Cash Flow
Real estate businesses focus heavily on investing cash flow (property acquisitions) and financing cash flow (mortgage payments, refinancing, etc.). Operating cash flow from rents is important but often secondary to these other flows early on.
Practical Tips for Small Business Owners
Now that we understand which cash flows matter most in different contexts, here are some practical tips:
1. Track All Three Cash Flows Separately
Don’t just look at your bank balance. Break down your cash flows into operating, investing, and financing components. This gives you much better visibility into your business’s financial health.
2. Focus on Improving Operating Cash Flow First
Unless you’re in the startup phase, prioritize improving your operating cash flow. This might include:
- Accelerating customer payments
- Extending vendor payment terms (when possible)
- Reducing inventory levels
- Increasing prices or reducing costs
- Focusing on higher-margin products or services
3. Be Strategic About Investing Cash Flow
Make sure your investments have a clear path to improving operating cash flow. Ask questions like:
- What’s the expected return on this investment?
- How long until this investment pays for itself?
- Could these funds be better used elsewhere?
4. Use Financing Cash Flow Strategically
Don’t rely on debt or equity financing as a crutch for poor operating performance. Instead, use it strategically to:
- Fund specific growth initiatives
- Manage seasonal fluctuations
- Take advantage of opportunities that exceed your current cash capacity
5. Monitor Cash Flow Regularly
Small businesses should review cash flow at least monthly, if not weekly. Look for trends and address issues before they become crises.
6. Maintain a Cash Reserve
Having a cash buffer provides flexibility and resilience. Aim for at least 3-6 months of operating expenses.
7. Create a Cash Flow Forecast
Develop rolling 3-month, 6-month, and 12-month cash flow forecasts. Update them regularly as conditions change.
A Holistic Approach: The Cash Flow Ecosystem
While we’ve been discussing which cash flow is most important, the reality is that all three are interconnected. I like to think of them as an ecosystem:
- Strong operating cash flow provides resources for investing activities and reduces reliance on financing.
- Smart investing cash flow decisions enhance future operating cash flow.
- Strategic financing cash flow management supports both operating needs and investing opportunities.
The healthiest businesses maintain balance across all three.
Conclusion: The Most Important Cash Flow Is the One You’re Ignoring
After years of working with businesses of all sizes, I’ve observed that the most dangerous cash flow is often the one that’s being ignored or misunderstood.
For many small business owners, that’s operating cash flow. They focus on revenue and profit but don’t track where their cash is actually going. For others, it’s investing cash flow—they don’t adequately plan for equipment replacements or growth investments. And for some, it’s financing cash flow—they take on debt without a clear plan for repayment.
The truth is, all three types of cash flow are important, just in different ways and at different times. The key is understanding which one deserves your primary attention given your business’s current stage, industry, and goals.
Remember, cash flow isn’t just about having money in the bank—it’s about understanding the patterns of how cash moves through your business. Master that understanding, and you’ve taken a huge step toward long-term success.
What cash flow are you focusing on today? And more importantly, what cash flow should you be focusing on?