While profitability is often considered a key indicator of business success, behind the scenes, it’s cash flow that can make or break your business. It’s the lifeblood of your day-to-day operations, and managing how cash flows through your business is vital to survival, financial stability and growth. With diligent financial reporting and a thorough understanding of managing and improving cash flow, your business will be poised for success.
What is cash flow?
Cash flow is the movement of money in and out of your business over a set period.
Cash flow in includes sales revenue and cash from loans and investments.
Cash flow out includes operating expenses and employee wages.
Cash flow example: A web design business achieved $10,000 in sales over one month. It spent $6,000 on employee wages, rent and other expenses during that month. It, therefore, has a positive cash flow of $4,000.
What are the different types of cash flow?
To manage cash flow effectively, these three types should be tracked and included in your cash flow statements.
1. Operating cash flow
This is all cash generated or used in your company's core activities — for example, sales of products or services and operational costs like wages, materials and other expenses.
2. Investing cash flow
This type covers transactions relating to long-term investments made by your business. It includes purchasing or selling real estate, securities purchased on the stock market or patents.
3. Financing cash flow
This covers all cash flowing in or out of your business relating to debts or equity payments — for example, taking out a business loan or making interest or dividend payments.
Why is it important to manage cash flow?
With a whopping 80% of businesses failing due to cash flow problems, how you manage cash can make or break the financial health of your business. Cash flow problems can stifle growth and leave your business scrambling to stay afloat rather than planning for the future.
Maintaining positive cash flow (meaning you've got more money coming in than going out of your business) is the best assurance that your company is in a solid financial position.
Common causes of cash flow problems
Cash flow problems happen when more money flows out of your business than in (negative cash flow), and when you don't have enough accessible capital to support your company during a negative cash flow period. The health of your cash flow can be influenced by your ability to manage these three aspects of business:
1. Accounts receivable
Accounts receivable represents money coming into your business from customers or other debtors and is often a challenging area of business. Problems occur when you don't send out invoices promptly, customers don't pay invoices on time, business terms are poorly negotiated, and when no one is effectively chasing late payments.
2. Accounts payable
Accounts payable represents money going out of your business to your suppliers and other creditors. Problems occur when you have poor accounts payable processes, you miss payments and incur penalties or disruptions to supply, or when budgeting for accounts payable isn't accurate and terms with suppliers are poorly negotiated.
3. Access to capital
This represents your access to external funding that isn't tied to day-to-day business operations. Sources of capital include traditional sources like banks, new avenues like crowdsourcing and peer-to-peer (P2P) lending and specialised loans for small businesses as well as leveraging equity in your company. Problems occur when a company doesn't have access to capital to see it through difficult periods (such as negative cash flow) or when high borrowing costs make it unfeasible.
How to effectively manage cash flow
Regular financial reporting and forecasting are the best approaches to managing your cash flow. Monitoring and analysing the three main types of cash flow — operating, investing and financing – and setting key performance indicators (KPIs) lets you track and analyse cash flow. These metrics are crucial for understanding whether you have enough money to pay suppliers, staff and operational expenses, and have cash available for new opportunities or investments.
Keeping a close eye on these metrics allows businesses to prepare cash flow forecasts more frequently and accurately — these help spot potential issues so they can be rectified or changed accordingly. Cash flow management software provides easy, real-time access to this information.
Benefits of improving cash flow management
Understanding and improving cash flow management helps you mitigate risks, remain resilient through difficult periods, better plan for the future, and identify and react quickly to opportunities for investment.
How to improve cash flow management
Your cash flow management can be improved in different ways depending on the industry and goals of your business. However, the main factors to consider are:
Managing cash inflows
This is the money flowing into your business. It includes income from selling products or services and other sources like investing and financing. Customer inflows can be improved by shortening or incentivising early payment terms, following up on outstanding invoices, sending invoices faster, and offering more convenient payment methods. If inflows are a consistent issue, you may need to examine your processes or ongoing financing may be required.
Managing cash outflows
This is the money flowing out of your business. It includes payments to your suppliers, costs like salaries and utility bills and expenses like tax. You can manage these by aligning expenditure with more robust cash flow periods, negotiating more favourable supplier payment terms, or investigating leasing of equipment rather than purchasing outright. You can also manage your outflows by reducing discretionary spending and renegotiating with suppliers.
Forecasting revenue and expenses
Accurate cash flow statements help you predict future cash positions by looking at where cash has gone and where it is coming from. These statements can be prepared monthly, quarterly or annually, and provide a clear picture of how much cash your business has available at a given time.
Tools and templates for managing cash flow
Cash flow analysis is an effective tool for managing your cash flow. Firstly, operating, investing and financing cash flow statements must be prepared, and then a cash flow statement can be prepared.
How to prepare a cash flow statement:
Gather financial documents and data, including balance sheets, profit and loss statements, past cash flow statements, material transaction records and artefacts.
Identify your opening cash balance.
List incoming cash.
Calculate your total incoming cash.
List outgoing cash.
Calculate your total outgoing cash.
Adjust for non-cash items.
Calculate your cash flow.
Calculate your closing cash balance.
Online tools will help you get to grips with cash flow forecasting and preparing your cash flow statement.
Cash flow management FAQs
What is an example of poor cash flow management?
An example of poor cash flow management is the inability to make on-time payments to your suppliers. This can damage supplier relationships, incur penalties, cause disruption in your supply chain, affect production, and impact your future profit.
What are common cash flow management mistakes?
Insufficient planning for or forecasting of your quiet periods, seasonal variances or unforeseen expenses are common cash flow management mistakes and a common cause of small business failure.
Is cash flow the same as profit?
No, cash flow is different from profit. Cash flow reflects actual money flowing in and out of a business, whereas profit indicates the amount left over after all costs are deducted.
How do you determine if you have a healthy cash flow?
In simple terms, a business has a healthy cash flow when more money comes in than goes out. This is a positive net cash flow.
Take control of your cash flow management with MYOB
Managing your cash flow is one of the most important things you can do to keep your business headed in the right direction. Thankfully, MYOB’s accounting software includes tools, features and dashboards specifically designed to improve and easily track your cash flow for your business. Get started with MYOB today.
Disclaimer: Information provided in this article is of a general nature and does not consider your personal situation. It does not constitute legal, financial, or other professional advice and should not be relied upon as a statement of law, policy or advice. You should consider whether this information is appropriate to your needs and, if necessary, seek independent advice. This information is only accurate at the time of publication. Although every effort has been made to verify the accuracy of the information contained on this webpage, MYOB disclaims, to the extent permitted by law, all liability for the information contained on this webpage or any loss or damage suffered by any person directly or indirectly through relying on this information.