Cash flow is the amount and timing of money flowing in and out of a business. A pretty simple concept to understand, but it’s easier said than done.
According to a report by ASIC, 51% of businesses that close their doors attribute the failure to inadequate cash flow or high cash use. And in report by Xero, 61% of business owners indicated cash flow was their biggest concern and a major cause of stress. With that in mind, let’s look at how you can manage and improve your cash flow so that your business has the ability to thrive all throughout the year, and for many years to come.
Types of cash flow
There are three types of cash flows. Operating activities, investing activities, and financing activities.
Cash flows from Operating activities is the money coming in and out of your business in relation to the production and sale of goods from normal operations. One of the primary reasons for monitoring operating cash flow is to know if your business has enough money to pay bills and operating expenses.
Cash flow from Investing activities is the cash flows related to investing and calculates how much money has been generated or spent on investment activities. If investing cash flow is in the negative, that could be attributed to longterm investments that will eventually contribute to the general health of the company, like research and development.
Cash flows from Financing activities measures the net flows of cash used to fund the company and its capital; things like debt, equity, and paying dividends. This can give an idea of the companies strength.
Cash flow vs. Profit
Cash flow is the money going in and out of a business, profit on the other hand, is the money leftover after expenses are deducted from revenue. Both are important and depend on each other, but are two different ways of assessing the health and success of a business.
Cash flow keeps your business moving and when analysed it can help determine the health of your business, predicting how well you can cover your debts and management expenses. Profit is income made after you have paid all your expenses. Without good cash flow, there would be no profit.
Positive Cash Flow
Positive cash flow is when your business has got more money coming in, than money going out. This has many obvious benefits including being able to reinvest into the business, pay expenses and future proof your business for challenges that may come up.
How to calculate, analyse, evaluate cash flow?
Calculating, evaluating and analysing cash flow is important in predicting growth and determining the health of your business. This can be done with a cash flow statement which shows how much your business is spending (cash outflows) and from where your business is receiving its money (cash inflows). The statement has three parts; operations, investing and financing.
Cash flow forecast can also be simply calculated using this formula:
Beginning Cash + Projected Inflows – Projected Outflows = Ending Cash
Regularly analysing your cash flow using a statement and projecting tools can help you evaluate whats working and what needs adjusting to ensure your business is looking healthy financially.
If you are new to accounting software, or looking for an easier way to generate cash flow statements for your business, you can quickly generate a cash flow with cloud accounting software. Cloud accounting software such as Xero have the ability to project cash flow statements by weeks or months. Check out our blog Streamlining your bookkeeping with accounting software for which cloud accounting software is right for you.
Calculating and analysing cash flow is a great practice to integrate into your monthly schedule as a business owners or business accountant. When you sit down to reconcile accounts, send invoices and pay your bills, why not quickly generate a cash flow statement to help keep an eye on your business health, and avoid any upcoming issues.
Why is cash flow important in business?
Cash flow enables your business to continue operating with ease, paying your expenses and investing back into the business. This is important in any business, but especially start-ups and small business, when income can be minimal and sales inconsistent. While a business might see profit every month, if it’s tied up in hard assets and investments then there’s no money accessible to pay employees or bills. Positive cash flow enables a businesses to pay bills on time, pay employees, and deal with any unexpected issues or opportunities.
5 strategies to improve cash flow for your business
1. Invoicing and Late payments
Send your invoices out as soon as possible and ensure your terms of payment are clear and easily understood, including a payment date and payment information. Sending out invoices quickly can help close a sale, shows your professionalism and of course, means that you are paid quicker.
Evaluate your payment terms to make sure your invoices are correctly formatted and include all the relevant information and payment terms. Whether your business requires a payment prior to work beginning or has a 30 day payment term, it is important to make sure this information is clear and suits your business and industry. If you are required to purchase materials (e.g as a builder) then taking a deposit payment prior to work commencement is extremely important. Do your research and create a great invoice.
Set up invoice reminder automations so you can set and forget. According to a report by Xero, just over half of small businesses receive invoice payments late, with payments arriving an average of 23 days after they are due. Avoid the hassle of awkwardly chasing people up with an automated email for late and overdue invoices by allowing your accounting software to do the heavy lifting for you. These can be set up before or after they are due. Every minute you don’t have to chase your customer or client for money (that should already be in the bank) is time you can spend on something else that makes you more money.
2. Use a cash flow statement to keep an eye on your bottom line and make adjustments
Using a cash flow statement can help ensure you are covering your expenses and managing the ebbs and flows of your business and industry. If your bottom line (what it costs to run your business) goes up, and your cash flow goes down, this can cause serious problems. As we mentioned earlier, reviewing your cash flow statements monthly (especially when you’re starting out) and understanding what is available in liquid assets will help when making decisions that raise your bottom line and expenses or alternatively, cut back your overheads to free up some cash.
3. Increase Pricing
Increasing prices is an obvious strategy, but sometimes gets overlooked. We often get concerned with lowering our bottom line and cutting down our expenses, but can forget that prices are going up every year and so should yours. Increasing your prices will free up more cash and keep up with inflation, and should be done each financial year. Communicating confidently and negotiating with your customers and clients is important in this process. If you decide to make the shift with existing customers, you may loose a few of the small customers and clients along the way but these might be the ones that only wanted your business because it was cheap. With an appropriate pricing model, you’ll start to attract the higher paying customers who will more profitable in the long term.
4. Know the seasonality of your industry and plan ahead
Seasonality is the reoccurring periods in the month or year where there’s a great or lesser demand for your particular product or service due to a specific reason. For some businesses and industries, seasonality has a huge influence on when the cash flows in. For many other businesses and industries, seasonality has a more subtle but still very present influence on when cash comes in. Making an effort to understand the seasons and influences on your cash flow, is a positive step in coming up with strategies to combat the dry seasons. Conducting some simple industry research, and looking back at year over year trends within your own business is an easy way of identifying these seasons.
Once you’ve identified the seasons and influences, you can develop your seasonal cash flow combat strategy, which sound fancy but might just be a simple fact that you don’t buy as much stock at times and run a “limited” or “exclusive” drop of products, building hype and more momentum. Or as a service-based business, you might think of ways to offering a non-seasonal service, implement monthly retainers, or a develop a subscription-based product.
Doing your research and thinking of ways to work smarter not harder can open up new possibilities for you and your business to maintain steady cash flow.
5. Growth
We’ve mentioned raising your prices, but how else do you grow your business?
Grow your business by leasing equipment, rather than buying them new. As you grow, you’re going to need new equipment, but purchasing new items can be a big hit to your cash. If you don’t have much liquid cash, that can be detrimental to your business. Leasing items helps with cash flow as you’re paying smaller, measured amounts at a time without taking a big financial hit.
Follow the profit by doing more of the thing that make you good money. After you’ve been running your business for a while, you may have noticed there are some particular jobs, items, projects, or clients that make you more money than others. Focusing in on those by marketing to them and making them more of a feature in your business can help with growth.
Adjust or expand your business model and pricing strategy. We touched on this tactic earlier in combatting seasonality in business, but it’s worth mentioning agaian ideal way of growing your business. As a business owner, learning and responding to your market and industry is essential for growth. Taking on new opportunities can put you outside of your comfort zone, but different streams of income can be highly effective in bringing the cash flow in, and growing your business.
Get a good accountant who can help you understand and maximise your cash flow opportunities. Getting an expert accountant to help with your cash flow is a smart investment in yourself and your business, saving you money and time. Check out our blog 11 benefits of having a (good) accountant. A good accountant business advisor can help you with any one of the cash flow strategies we’ve outlined, and is a great way of making sure any decisions you make are right for you and your particular business.
Summary
Understanding cash flow in business and your particular industry is the first step in overcoming cash flow issues in your business. Once equipped with the knowledge, implementing changes and trying new ways of doing business will be the ultimate vehicle for you to increase cash flow in your business. There’s no one-size-fits-all solution to increasing cash flow, but being proactive and getting started by choosing and testing one of these strategies for yourself is the best thing you can do.
With 51% of businesses failing due to inadequate cash flow, it’s a big challenge, but something that any business owner can overcome with the right advice, strategy and as always, persistence.
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We’re CPA accountants and advisors helping business owners strategise and implement effective cash flow strategies that will take their business to the next level.
