Managing cash flow is one of the most crucial aspects of running a successful business. Despite its importance, it’s often misunderstood or not given due consideration by business owners. This blog will break down the basics of cash flow, how it works, and how you can analyse it to ensure your business remains financially healthy and viable.
What Is Cash Flow?
Cash flow refers to the movement of money in and out of your business bank accounts over a specific period.
- Cash Inflows: Money entering the business from transactions such as sales, loans, or investments into your business.
- Cash Outflows: Money leaving the business, including expenses like salaries, rent, utilities, and loan repayments.
The goal is to maintain a positive cash flow, meaning your cash inflows exceed your cash outflows. This then allows you to ensure that you can always pay your expenses and ensure the business stays out of financial trouble.
How Cash Flow Works
Cash flow can be split up into three categories:
- Operating Activities: Revenue from sales and expenses related to running the business.
- Investing Activities: Purchases or sales of assets, such as equipment or property.
- Financing Activities: Borrowing or repaying loans and issuing shares in your business.
These components collectively determine your net cash flow.
Why Cash Flow Matters
- Business Survival: Without enough cash to cover short-term expenses, businesses risk going broke.
- Decision Making: Understanding cash flow helps in planning for expansion, hiring, or investing in new opportunities.
- Creditor Confidence: Positive cash flow improves your creditworthiness, making it easier to secure financing from banks.
How to Analyse Cash Flow
Analysing cash flow involves examining the numbers to understand trends, identify potential issues, and plan for the future. Here’s a step-by-step guide:
- Review Your Cash Flow Statement (with the help of your business accountant)
The cash flow statement is a financial report detailing inflows and outflows. As mentioned previously, it’s divided into:
- Operating Activities: Day-to-day revenue and expenses.
- Investing Activities: Asset purchases and disposals.
- Financing Activities: Loans and equity transactions.
2.Calculate Key Metrics
- Net Cash Flow: Total inflows minus total outflows. Positive net cash flow indicates you are receiving more money than you are spending.
- Cash Flow Forecast: Predict your future inflows and outflows based on historical data and future assumptions. Again, a business accountant can help you prepare a cash flow forecast.
3. Assess Cash Flow Patterns
- Seasonality: Many businesses have periods of high and low activity. Recognising these patterns helps in planning.
- Recurring Expenses: Identify fixed costs to ensure you always have enough cash to cover them. In the event that you are yet to start your business, contact an accountant Melbourne to discuss some of the fixed costs that you might encounter.
4. Compare to Budget
Regularly compare actual cash flow to your budget. This highlights variances and helps adjust your plans accordingly. Your accountant Melbourne can help you with the preparation of the budget.
5. Use Ratios
Ratios offer deeper insights into cash flow health:
- Operating Cash Flow Ratio: Operating Cash Flow / Current Liabilities. This shows how well your cash flow covers short-term liabilities.
- Free Cash Flow: Operating Cash Flow – Capital Expenditures. Indicates how much cash is available for growth or distributions.
Contact your business accountant, like Nobel Thomas, who can further explain the above and some other commonly used ratios.
Tips for Improving Cash Flow
- Speed Up Receivables: Encourage customers to pay on time by offering discounts for early payment.
- Negotiate Payables: Request longer payment terms from suppliers.
- Cut Unnecessary Expenses: Regularly review expenses to eliminate waste. Contact your accountant Melbourne who can also advise if your expenses are more or less than average for your industry.
- Maintain a Cash Reserve: Always have a buffer for emergencies or unexpected opportunities.
Understanding and managing cash flow is vital for the sustainability and growth of your business. Regularly reviewing your cash flow allows you to identify potential challenges early and take proactive measures to stay financially healthy.
Whether you’re a startup or an established business, developing a robust cash flow strategy will allow you to make smarter decisions, seize new opportunities, and deal with financial speed bumps with confidence.
Don’t hesitate to contact your business accountant, like Nobel Thomas, for a no obligation discussion.
