Cash flow is the net amount of cash coming in and going out of the business.
Cash received is an inflow, and cash spent is an outflow, according to Investopedia.
Cash flow is a critical factor in determining the viability or profitability of a business. And, if a company can generate positive cash flow (that is, more money coming in than going out), it’s deemed a commercial success.
The ultimate goal of any business owner is to have as much positive cash flow reoccurring regularly, without the need for any business loan ( this links to the previous blog ). Conversely, businesses that experience extended periods of negative cash flow are in danger of closing or going bankrupt. According to the Australian Financial Security Authority, There were 12,450 bankruptcies in 2019–20.
Keep this number in mind when you start a business and make sure you have enough cash to keep you viable during the startup phase.
Understanding the cash flow statement
There are three significant outcomes you need to be aware of when examining a cash flow statement. These are your costs, timings and the uncertainty of cash flows. Even the best businesses and franchises all have cash flow uncertainty.
You will find crucial information on the businesses cash flow statement, and your accountant should be able to provide this to you if you don’t know how to create one. This statement will tell you exactly how much cash you have on hand at a particular time and is a handy barometer to measure your business’s financial health and stability.
Why you need regular cash flow statements?
Cash flow statements are vital for three reasons:
a) You can easily measure your liquidity. Any business owner needs to know how much cash they have if they want to buy equipment or expand it. It’s a vital piece of information that allows you to plan for growth.
b) They show you levels of assets, liabilities, and equity that you hold in the form of cash expenditure, cash inflows, and cash. Assets, liabilities and owners equity in the business is the cornerstone of your accounting, and you need to know your financial position.
c) They let you predict future cash flows. If you want to plan for the future, cash flow projections allow for this.
More importantly, if you plan on securing a business loan or line of credit, you’ll need up-to-date cash flow statements.
10 Ways to Improve your cash flow
- Lease for now and don’t buy – you don’t want to outlay a considerable chunk of cash which may suffocate your businesses cash flow. That is unless you are flushed with money.
- Offer Discounts for Early Payment – give your customers the incentive to pay early and on time.
- Conduct Customer Credit Checks – so you don’t end up dealing with shonky payers who are likely to leave you out of pocket.
- Form a Buying Cooperative – you will get buying discounts in large volumes.
- Improve Your Inventory – get rid of stock that’s not moving, selling, or sitting on the shelf for a long time.
- Send Invoices Out Immediately – the longer you wait to send an invoice out, the longer it will take you to get paid. Your not a bank, and you don’t lend money. Get paid and get paid fast!
- Use Electronic Payments – this way; you can wait till the due date to pay, which keeps the money in your account for longer.
- Pay Suppliers Less – a bargain for better trading terms with suppliers you have a good relationship with and perhaps try to get discounts here and there.
- Use High-Interest Savings Accounts – a no-brainer but shop around for this online.
- Increase your prices – many small business startups will lower their prices to buy the customer. Do this for a while, then slowly increase your prices to reflect the market.
Free cash flow (FCF)
Free cash flow (FCF) shows if a company is profiting from its operations, which gives you a clearer idea of the businesses performance rather than relying on net income. It’s an important metric as it shows the cash in the bank after expenses. If your FCF is positive, you can use this to expand the business, pay dividends or repay debts.
Types of cash flow
There are several types of cash flows you need to know:
a) Cash from Operating Activities: This is the cash generated from your day to day operations.
b) Free Cash Flow to Equity (FCFE): This shows the amount of cash in the bank after all expenses and capital equipment purchases.
c) Free Cash Flow to the Firm (FCFF): This is a financial model that shows that a company doesn’t have any debt or leverage.
d) Net Change in Cash: This is the change in Cash flow from one accounting period to another.
Cash Flow Statement vs. Income Statement: What’s the Difference?
We have discussed the businesses cash flow, but the income flow is different. It measures the business’s financial performance, including; revenues, expenses, profits, or losses over a specific period.
The significant difference to note is that an income statement shows whether a business made a profit. A cash flow statement indicates whether a company generated cash in the positive or negative.
Both are crucial factor for businesses in reaching their long-term goals.
Profitable Businesses Can Go Bankrupt – I bet you didn’t know that!
It’s essential to get your head around cash flow vs. profit.
Just because you have a busy business with many customers spending money doesn’t mean you are doing well.
For example, you might sell $50,000 worth of goods on credit, offering your customers 30-day terms. However, you might have ordered $30,000 cost of supplies to make your goods, and you have to pay your suppliers within 30 days.
Consider all the other expenses you have like rent, staff, utilities etc. Plus, what happens if you get a few bad debts from customers you have given credit to? Boom, you have negative cash flow, and your all of a sudden in trouble. It’s a massive juggling at so you have to have your finger on the pulse of your business the whole time. Take your eyes off it for a minute, and you’re in deep trouble.
You might think you’re doing OK because the phones are ringing and orders are coming through, or you may be getting new clients, but the reality is far from that. Watching your cash flow is keet to the success of your business and its survival.
If you’re a business owner and need a loan to help you get through some tough times, the team at Sparrow Loans are here to help.