How to improve the cash flow of your business?
Having full visibility over cash flow is absolutely crucial for any business, from the smallest of start-ups to the biggest of international conglomerates.
Your cash flow essentially tells you whether you’ve got enough money to keep growing or if you’re at risk of going broke — and by knowing where you sit on this spectrum, you’re in a far better position to make the right decisions and prevent the latter from occurring.
What is cash flow and why is it important?
Cash flow is the movement of money into and out of a company over a specific period of time — the inflow and outflow of cash resulting from various business activities, including sales, expenses, investments, and financing.
Positive cash flow occurs when a company’s cash inflows exceed its cash outflows, indicating that the company has more cash coming in than going out. Negative cash flow is the opposite — cash outflows exceed cash inflows, meaning that more money is being spent than is being brought in.
We hopefully don’t need to tell you why positive cash flow is preferable to negative cash flow and why the former is crucial for effective, sustainable business operations.
How to calculate cash flow
There’s a simple cash flow formula that virtually any business can use to calculate its net cash flow and gain insight into its financial health.
To calculate net cash flow, simply subtract the total cash outflow from the total cash inflow.
Net Cash Flow = Total Cash Inflows — Total Cash Outflows
Cash flow example
Bradbury Ltd has monthly inflows of £40,000 but outflows of £50,000, its net cash flow would be -£10,000 and it would be in negative cash flow. To try and keep out of the red, many businesses conduct what is known as cash flow forecasting.
Benefits of a cash flow forecast
As most business owners will know, the amount of money flowing in and out of the business month-to-month can vary, particularly for those offering seasonal products and services. Just because a business has negative cash flow one month doesn’t necessarily mean it’s in trouble. If it’s a long-term pattern, however, that’s a whole different story.
Cash flow forecasting is the process of estimating and projecting the future inflows and outflows of cash for a business over a specific period so that businesses can gauge the state of their cash flow over time.
It involves predicting the timing and amount of cash that will be received from customers (cash inflows) and the timing and amount of cash that will be paid out to suppliers, employees, lenders, and other expenses (cash outflows).
By forecasting cash flows, businesses can anticipate periods of cash surplus or deficit, identify potential cash flow problems in advance, and make informed decisions to ensure sufficient liquidity. As such, cash flow forecasting is a critical process for any business.
How to build a cashflow forecast
While the difficulty of building a cash flow forecast will vary depending on the nature of each individual business and its finances, the process for doing so is largely the same for everyone. It generally involves the following:
- Analysing historical financial information to gain insight into historical cash flow patterns.
- Identifying the various sources of cash inflows, such as revenue from sales, accounts receivable collections, investments, loans, and any other sources.
- Estimating cash inflows based on sales projections, historical collection patterns, and customer payment terms.
- Identifying cash outflows such as supplier payments, employee salaries, utilities, taxes, loan repayments, and other operating costs. Also consider non-operating payments such as asset purchases, and loan repayments.
- Organising the information by creating a structured forecast that summarises estimated inflows and outflows on a monthly and quarterly basis. You can use a spreadsheet or cash flow forecasting software to input the data and calculate the net cash flow for each period.
5 ways to improve your cash flow
Prevention is better than the cure, as the saying goes. It’s always a good idea to ensure that the decisions you’re making are in the interests of positive cash flow to prevent any issues from arising further down the line. With this in mind, here are five ways to ensure better cash flow:
1. Lease rather than buy
Unless you’ve got lots of spare cash to play with, you’re going to want to lease equipment rather than buy it. This may seem counterintuitive but doing so helps to maintain your cash stream for day-to-day operations as payments are made in small batches. Lease payments are also a business expense and can therefore be deducted from taxes.
2. Send invoices early
Many businesses need more time to send invoices to their customers. This naturally leads to delayed payments, which can place a strain on cash flow. Send them sooner rather than later and ensure that critical information such as due dates, payment details, and any instructions are clear and visible. If you want to learn about invoicing, check out this article.
3. Accelerate customer payments
In a similar vein to sending invoices promptly, encourage early payment by offering discounts for early payments or implementing stricter credit terms. Everyone loves an incentive after all, and you’re creating a positive situation not just for your business but your customer, too. This might encourage them to return in the future.
4. Streamline your expenses
Review and identify areas where expenses can be reduced or eliminated without impacting core operations. Renegotiate contracts with vendors to secure better terms or seek more cost-effective alternatives. Monitor expenses closely and implement cost control measures if you’re at risk of negative cash flow.
5. Forecast and plan ahead
We’ve already mentioned this, but we’ll say it again because it’s just so important: get comfortable with cash flow forecasting. Developing a comprehensive cash flow forecast to anticipate periods of cash surplus or deficit helps you to plan and adjust accordingly, such as securing additional financing during cash flow gaps or taking advantage of opportunities during surplus periods. You can also investigate how much it costs to make a product, and whether you can keep costs down by sourcing new suppliers. Work it out by using a variable cost formula.
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