Cash Flow

Your guide to cash flow

No business can afford to ignore its cash flow. Monitoring this is like monitoring your pulse – it’s a crucial health check for your business. Indeed, more than a third of SMEs cite issues with cash flow as a barrier to their growth.

It’s crucial to understand what your cash flow is, how to calculate your cash flow and how to use a statement to keep on top of this.

 

What is cash flow?

Cash flow refers to the movement of money in and out of your business. Ideally, you want to try to have a positive cash flow – meaning that more money is coming in to the business in sales or new orders than goes out in bills and expenses. If you have a positive cash flow, your business will be able to settle its bills and invest in growth. If it has a negative cash flow, it will need to find an alternative source of income to be able to pay its debts and need to work on turning this around.

So, if you want to work out the net cash flow, you just add up all of your cash payments over a set period (typically a month) and take that away from your cash receipts. It’s important not to get too hung up on one particular month, however. Your cash flow can be more accurately judged over a period of three months or more since most businesses will, naturally, have peaks and troughs.

While your turnover might be a nice big number that gives you confidence that your business is doing well, it’s the cash flow that offers a better insight into how well your business is managing. As the old saying goes – turnover is vanity, profit is sanity and cash flow is reality.

 

What happens if you don’t keep on top of your cash flow?

Failing to monitor and manage your cash flow puts your business at risk and could lead to a range of different problems. Here are some of the main issues you might face:

  • Too much stock. If you suddenly receive high demand for a product, it’s tempting to order a high volume of material to service that demand. However, if that demand then changes you could be left with far too much stock and, potentially, debt from ordering the materials. Ordering too much stock might also leave you lumbered with materials that become obsolete and difficult to sell.
  • Long payment terms. Lengthy payment terms can often leave you with long stretches of time when no money comes in. Any unseen issues, right from a fire at the office to the need to replace a laptop, can then be problematic due to a shortage of cash while you wait for the money to arrive. There’s also the possibility of bad debt, which is when customers do not pay at all.
  • Overspending. It’s very tempting to go on a spending spree when you win a new client – snapping up everything from fancy orthopaedic chairs to an office ping pong table. However, you need to remember that you haven’t actually got the money until they’ve paid you. Spending money that you don’t have is never the best idea.
  • Overtrading. Just as with stock, it’s easy to get carried away with your business outlook after securing a big order. Employing more staff or expanding to more locations might seem like a good idea to grow your business, but you need to have the cash flow to back this up. While your profits can vary, your rent and salaries won’t, meaning that you need to be able to withstand short term pressure on your finances if you want to grow your personnel and premises.

 

Cash flow statement

Given the importance of cash flow management, it might well help to produce a statement that demonstrates this. A cash flow statement looks a lot like a profit and loss statement and the balance sheet. It should aim to look at how cash moves in and out of the business which, in turn, allows you to:

  • Consider how funds move through the business
  • What impact cash flow has on the running of the business
  • How payments reconcile with cash balances and values

In essence, you should see a cash statement as a condensed version of the balance sheet that you produce once a year. The end result of your statement should be a ‘Net Cash’ figure, which is the ultimate figure derived from all the other numbers in your report.

 

What to put in your cash flow statement?

A cash flow statement should be made up of three categories: operating, investing and financing.

Operating: This is your net income, plus or minus increases or decreases in your current assets and liabilities and expenses.

Investing: This figure reflects any increases or decreases in long or fixed term assets (independent of accumulated depreciation).

Financing: This reflects any increases or decreases in long term liabilities/debt, owners’ capital or dividends.

Once you have these three figures, you either add or take them away from your beginning cash balance to get your overall net cash balance.

 

Why produce a cash flow statement?

As well as giving a summary of how much cash is available for operations, the cash flow statement also details the ways in which the business is generating cash. In turn, this reveals a lot about how (or, indeed, if) growth is taking place, i.e. whether it is through increasing debt, income etc. This sort of information is important if you want to be able to plan ahead. You might even wish to make a cash flow forecast, based on how you think changes you are making to the business will be reflected in future cash flow statements.

This statement is a way of ensuring that you are going to be able to pay all of your bills. As a start-up, it might indicate when you need to get an alternative source of finance as you find your feet, while seasonal businesses can use this to track what happens during peak season and quieter times.

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