What Is Retained Cash Flow and Why It Is Important for Your Small Business
What Is Retained Cash Flow and Why It Is Important for Your Small Business
If you have ever run a marathon, you know that in between, water helps hydrate the body so you can continue for longer.
What if you ran a marathon and there were no water stations? You would start strong, but you would feel exhausted as time passes. Eventually, you’ll slow down or quit.
Now, think about your business. Revenue is your movement, but retained cash flow is your water station. Without it, you’ll struggle to sustain your business.
The problem is that many business owners focus on making money but overlook how much they’re keeping, and that’s where things get risky. So, let’s talk about retained cash flow and why it’s important for small businesses.
What is Retained Cash Flow (RCF)?
Before diving deeper, let’s talk about retained cash flow (RCF). Simply put, it’s the amount of cash your business has left over after covering all expenses, debt repayments, and any money returned to investors (including dividends).
A healthy business usually has positive retained cash flow, meaning it’s bringing in more than its spending.
On the flip side, negative retained cash flow signals trouble ahead, which means your company is spending cash faster than it can generate. And when that happens, your business growth slows down.
Now, if you’ve heard the term retained earnings, you might wonder—what’s the difference?
Retained Cash Flow vs. Retained Earnings
These two might sound similar, but they measure very different things.
Retained earnings don’t factor in cash flow. Instead, they track your cumulative profits and losses over time. It’s the portion of your earnings that hasn’t been paid out as dividends or spent on expenses.
For example:
- Your business earns $5 million in profit
- You distribute $1 million in dividends and expenses
- What’s left? $4 million in retained earnings
However, retained earnings have nothing to do with cash flow. They won’t show up on your cash flow statement, and for this discussion, we’re not focusing on them.
How is Retained Cash Flow Used?
Retained cash flow helps you gauge whether your company is making progress or the growth is slowing.
By tracking retained cash flow, you get a clearer picture of:
- Revenue – How much cash is coming in?
- Expenses – Where is your money going?
- Budget efficiency – Are you managing your cash flow wisely, or is money slipping through the cracks?
Why Does RCF Matter?
When your business retains cash instead of spending every dollar it earns, you gain financial stability and long-term growth potential.
Here’s why RCF matters for your business:
1. Financial Stability
A positive retained cash flow acts as a financial cushion. It helps businesses navigate unexpected downturns, economic slumps, or industry slow seasons without scrambling for emergency loans or cutting costs abruptly.
2. Business Growth and Expansion
Having a strong RCF means you can reinvest in your business without relying heavily on outside funding. The more cash you retain, the more control you have over your growth.
3. Reduced Dependence on Loans and Investors
A healthy retained cash flow reduces the need for high-interest loans or giving away equity to investors. Instead of owing money, you’re using your resources to fuel your next move.
4. Stronger Negotiation Power
With cash reserves, your business has better leverage when negotiating with suppliers, investors, and banks. Cash on hand means you can demand better payment terms, secure discounts, or invest in bulk purchasing to lower costs.
5. Increased Business Valuation
If you ever plan to sell or attract investors, a strong retained cash flow signals a well-managed business. A company that consistently retains cash is more attractive to buyers and investors, leading to higher valuations.
On the other hand, if your RCF is negative, reinvesting might not be an option. Instead, you might need to hold onto cash to cover debts.
That’s why retained cash flow is one of the best indicators of a company’s long-term financial health. The more you understand it, the better positioned you’ll be to make smart and strategic business decisions.
How to Calculate Retained Cash Flow?
Now that you know why retained cash flow matters, let’s break down how to calculate it so you can start using it in your business.
The Retained Cash Flow Formula
If you don’t already see a retained earnings adjustment on your cash flow statement, don’t worry; you can calculate retained cash flow yourself by following these simple steps:
- Obtain your cash flow statement – This is your starting point.
- Find your past cash flow statement – You’ll need this for comparison.
- Determine RCF for both periods by:
- Calculating starting cash and cash equivalents
- Subtracting dividend payments
- Subtracting cash expenses
- Compare both periods – Subtract the previous period’s RCF from the current period’s figure to see if your retained cash flow is improving or shrinking.
If you can’t do this manually, tools like QuickBooks and other financial forecasting software can simplify the process.
Tips for Improving Your Retained Cash Flow
If you’ve run the numbers and your retained cash flow isn’t looking great, don’t worry; there are plenty of ways to improve it.
- One of the most effective approaches is tightening up debt management. Too much cash sitting in unpaid invoices can strangle your liquidity, so streamlining accounts receivable should be a priority.
- Automating the invoicing and debt collection process can help you get paid faster while reducing the hassle of chasing payments.
- You might also consider offering early payment incentives to encourage clients to settle their balances sooner.
- Another area to examine is pricing strategy. Regularly reviewing and adjusting your pricing can help you increase revenue without needing more customers.
- At the same time, looking for inefficiencies in your spending can uncover ways to cut unnecessary costs and improve your bottom line.
Final Thoughts
So, now you know what is retained cash flow. When managed effectively, it provides the flexibility to reinvest, scale, and track unexpected challenges without relying on external funding.
The most important thing is not how much money your business makes; it’s about how much it keeps. The better you manage your retained cash flow, the more control you have over your business finances.
Speaking of finances, isn’t it good to have a partner by your side who can help you keep a healthy cash flow in the long run?
Tangent has years of experience as a CFO, business coach, and tax consultant. With us, you don’t need to hire an accountant or business coach separately; you can get both in one place.
P.S. If you are reading this, it means you can have access to our free consultation for your business. Avail this for free today before we change our mind 😉
FAQs
What is the remaining cash flow?
The remaining cash flow is left after all expenses, debts, taxes, and reinvestments have been deducted. It represents the final available cash balance a business holds.
What is the difference between free cash flow and distributable cash flow?
Free cash flow is the cash available after operating expenses and capital expenditures, while distributable cash flow is left after all obligations, including debt and reserves, are met.
Can cash flow be negative?
Yes, negative cash flow means your business is spending more than it’s earning, which can lead to liquidity issues and hinder growth if not managed properly.