Cash flow is one of the leading indicators of the financial status of your business. It is the one that reflects the liquidity of your trade, and its essential utility is to ensure the best possible use of money.
One of the biggest challenges of accounting analysis is to reflect the financial reality of the business. At first glance, a trade may seem very healthy in your accounts. But it is important that beyond the results, pay attention to the cash flow of your business. This indicator is composed of the accounting result of your business + depreciation + provisions. That is, in a given period, the results, amortisation and rules are added.
Amortisation is a cost that does not imply money withdrawal at the moment. They represent an asset you work with, without meaning a real outlay. Then, through the cash flow, your financial availability, or the cash that your business can generate in a given period is clarified. A cash flow statement allows you to manage income and expenses to anticipate financial problems.
Importance of cash flow
It will reveal the financial health of your business, its progress, and its evolution. Provide information about your real possibilities of fulfilling payment commitments. You will know if you generated enough cash to meet your suppliers and creditors and also, how an investment will impact your cash flow projection. It is an indispensable tool to adapt your needs to your real possibilities.
Here will appear the different types of cash flow and cash flow problems, which are divided according to their origin. Given the operation, that arises from investments or divestments and the one that results from the financial services, you will also have to adapt it according to the destination: shareholders, reinvestments, debt amortisation, among others.
Challenges and limitations of cash flow
Cash flow is especially useful for comparing different exercises, but it has its limitations. The point is that the accounting benefits are being computed as collections, which is not real. Having invoiced and accounted for a sale does not imply that you have collected it. Part of the sales and profits of an exercise may be pending collection in the second. They may not even be charged, and you have accounted for them.
That does not mean discarding a cash flow forecast, but understanding its limitations and using different ways to calculate it. For some purposes, the exemplary accounting cash flow can help you. But for others, you can use the methods of direct or indirect estimation of cash flows.
A simple spreadsheet will avoid many money problems for your business or commerce. Good cash flow will allow you to have in view the projected income and expenses to make better decisions.
These are the most common mistakes when working with cash flow:
- Confuse economic and financial aspects: In financial flows, you have to consider money when it is paid or charged. Unlike economic flows, this is beyond when the operation was generated. If you enter income as a sale that you are not going to cost for a couple of months, or you do not subtract the tax withholdings, you run the risk of believing that you have more money to make payments. Economic data helps in making some decisions, but if you mix them in the flow of funds, they can be very confusing.
- Lack of up-to-date and reliable information: The idea is that cash flows can help you make the right decisions. For that, you need your data to be up to date and complete. You can get a precise idea of the net cash flow and avoid the accumulation of papers and vouchers and schedule at least one weekly review. If you don’t have the exact information, use the best possible estimates.
- Not understanding the meaning of the numbers: To carry out a trade, you need to handle certain basic concepts. They will help you understand the message behind your numbers.
- Do not link income and expenses: Relating payments to collections is essential to avoid losing control. Marking with the same colour income and costs of the same product or account and delaying payments to suppliers if customer collection is delayed can help you a lot.
- Mix in the flow of personal or family money: It usually happens that in business or commerce, part of their own money or some family member is managed from the cashier. You must identify those items and understand that they do not correspond to the flow of trade funds. That way, you make sure you don’t get hurt.
- Do not act according to the information you get: The data of the flow of funds are not only to know better what happens in the business but to decide what should happen. With this information, you can plan payments, look for ways to improve collections, define investments, or borrow with peace of mind, before reaching an emergency.
Proper capital management gives us more chances to extend the healthy life of our business.
Positive net cash flow indicates that we have entered more resources than we have lost. When measuring the amount of cash, positive cash flow means that the company’s current assets are increasing. Thanks to existing assets, we obtain liquidity to face debts, investments and payments to shareholders.
Also, positive cash flow is great for investors, loan applications, or the security of a creditor by providing credit sales if we see that our cash flow is negative, we should know what to do if our account threatens to be negative. That is cash management 101.
Types of cash flows you should know
Cash flow from operations (FCO): Entry or exit of money as a result of the economic dynamics of the business.
Investment cash flow (FCI): An expected influx of money to your business as a result of sales or acquisitions of non-current assets.
Financial cash flow (FCF): A consequence of the issuance or return of debts or other financial resources.
What information does Cash Flow provide me?
- Inform the company about their financial status and health.
- We can project future entries and exits, allows us to anticipate a cash deficit and consider financing alternatives such as crowdlending, thus eliminating unforeseen events. One of the possible solutions to this shortage of liquidity can be solved by choosing between the different financing formulas. However, if we find a positive balance, we can consider management options for this current asset. One option may be to invest it either in our business or in the Capital Market.
Cash flow is an excellent method to acquire information about financial statements. In turn, it helps us to anticipate future inconveniences. Therefore, the first evaluation of it must be taken for the decision making of the company. Not always having a large number of assets means having a high availability of liquidity. That makes it a handy tool to analyse the situation of a business.
Reasonable cash flow control is essential to maintain financial health. Small and medium-sized companies, when dispensing with a commercial department, it’s very good to leverage tools and solutions that outsource financial analysis and control. Finutive acts as a virtual financial advisor and keeps the cash flow under control. You will see how your business finances become more efficient.
3 Tips to Improve Cash Flow
1. Increases cash inflows
Companies make money by selling products and services in different ways, and it largely depends on their business model. A business that is more consumer-oriented, such as a café or a restaurant, take immediate payments from customers. This way, cash comes quickly and faster. That allows restaurant businesses to have a constant and ongoing inflow of money.
At the same time, some companies do not generally receive immediate payments from their customers. This business model is standard in the B2B (business to business) sector. For instance, Company A does not make direct sells to a customer. Instead, it sends an invoice with a validity of up to a few weeks.
The most effective way to improve cash flow in this regard is by doing the following things:
- Proper billing: Generating invoices and drawing up bills may seem like a monotonous and tedious task. However, as soon as a business completes a service or delivers a product to their customers, they should also dispatch the invoice immediately, containing the details of payment terms and the breakdown of payment. The due date should also be visible and apparent. Any additional information should also be added to the final invoice, as in to avoid delay in payments.
- Keep track of defaulters: There are always customers who would not follow the practice of making payments on time. There are many reasons for it, but for a business, it can be a problem in the longer run. In this regard, customers should be chased to get updates regarding the payment. Of course, all communication should be carried out in a thoroughly professional manner.
- Renegotiate payment terms: This is all about making sure your customers make payments on time. It is certainly not about increasing your prices or forcing customers to pay a higher price for the same level of service/product. There are different ways using which a business can convince its customers to make timely payments, or within the timeframe, it is expected. It comes to the relationship between a business and a customer shares. If it is a mutually benefitting and healthy relation, the customer may take into consideration any such request forward by the business.
Small businesses may have a difficult situation to deal with here. They cannot always push larger companies for flexible payment terms, as in not leave the wrong impression. It is still mindful for UK businesses to keep notice of these payment terms provided by the UK government.
2. Reducing cash outflow frequency
The first strategy is to increase cash inflow. But we cannot ignore the expenses and incorrect tracking as to where the money of the business is going. Curbing on costs is a challenge that every company in the UK faces. One of the most effective strategies is to control where you plan to invest. For many businesses that are not as profitable, investing back into the company would be a luxurious prospect, quite challenging to achieve.
Even if your business is new in operation, you are supposed to take a step back from investing back into the market as a way of increasing growth. In the long term, it can be detrimental to your cash flows.
3. Achieve a balance
No matter what strategy you employ to improve short term and long term cash needs of your company, the most effective strategy is to find a balance between inflow and outflow.
To make sure that you have constant, working capital at your disposal, allow your business to have the cash immediately available to meet your short-term business needs. If your company earns a surplus, then save it back and prevent from re-investing or spending without many purposes. Also, any credit payments should be paid in the first instance to avoid the charges of interest.
However, it can also cause a long-term disadvantage and hurt your business growth. If your business continues to save profits and not invest in the market, then growth would come to a halt. The primary purpose of any marketing is to be profitable. Scaling up a business means having higher yields, which can be spent on marketing, promotion, R&D, etc. to achieve more growth.
By learning to forecast cash flows and maintaining a balance, it allows companies to stay on the right track and meet their most dire capital needs. Through the cash flow strategies explained in this article, your business can improve the financial situation and be more sustainable in the long term. These tactics are applicable and practical, both in the short and long time. You can avoid a cash flow problem, which becomes a disaster in the long term if not rectified.
With adequate cash flow, you can steer your business towards more growth and feel confident about attracting more investments. Plus, it also looks good on the books and can be a convincing factor for banks to provide loans or investors looking to inject capital.
Shoaib Aslam is the co-founder of Pearl Chartered Accountants, a UK-based chartered accountancy firm that has multiple locations across London. They are experts in helping startups and established businesses with all aspects of growth, strategy, scaling up, accounting and tax planning.