What is cash flow?

A cash flow is a tool used to show how money is made and spent in your business. A cash flow statement details money coming into and out of the company. Using a cash flow statement can help you and your business keep on top of financial obligations and can be used as a tool to plan for future expenditures or projects.

Here are four reasons why cash flow is so important:

Make better decisions
With an accurate cash flow statement, you will know what funds are available and is useful in identifying pressure points, i.e., decreased sales during holiday periods, additional expenditures in winter etc.

Control spending
With effective cash flow management, you will get oversight on where exactly you are spending money. This, in turn, can identify areas where you can cut costs.

Planning for growth
Growth means not only additional revenue, but also additional costs – advertising, wages, recruitment fees, and additional stock. You will need to have funds available to meet these additional expenses, costs will be incurred before additional revenue will be available.
Cash flow will help determine when you should expand.

If the business requires funding, e.g., a loan for new equipment, an overdraft or wishes to apply for government funding, you will require a cash flow statement in support of your application.

If you haven’t used a cash flow model before, now is the perfect time to start. If your company issues invoices for future payments, a cash flow statement is vital as it gives a real-time view of the company finances. A cash flow statement only takes account of cash (payments) received. Even when a company is profitable in the long run, there can be occasions when you simply do not have enough money to pay the bills. This is especially true for companies that issue a lot of invoices and who have longer credit terms.
A cash flow will also highlight the best time to make capital investments or once-off purchases – new office equipment, upgrades to machinery, new heating systems etc.

In this cash flow model, we have used excel. Calculations are automatic and it is an excellent foundation for a cash flow model.

As you become more confident, you can tweak the information and produce a more complex and informative cash flow statement.
A more sophisticated cash flow statement will include:

Operational activities
Day to day business activities. For most SMEs, this will account for most of the income and expenditure.

Investments activities
The value of assets owned by the business – equipment etc. When a company purchases equipment, the cash equivalent is deducted from the cash in hand value. You now have an asset with an associated value, however, the cash used to make the purchase is gone.

Financing activities
This section includes loan repayments, and credit card interest which are expenses incurred by the business. When a company drawdown a loan, its cash increases by the loan amount.

Ideally, a positive cash flow should fund investments in the business. I.E., the business should generate sufficient cash to fund capital expenditure (i.e., equipment for production, cars for sales staff etc.) If this is not the case, the company may need funding for capital expenditure (Cap. Ex) in the form of leasing, a term loan or equity injection by shareholders or third-party investors.
Cash flow should be sufficient to cover repayments.
If a company shows periodic /seasonal negative cash flow, there may be a requirement for an overdraft to meet cash flow requirements. Government grants are also a good source of funding for SMEs on a growth plan.

Even when a business is profitable, it can still have a negative cash flow. Most businesses can absorb an occasional negative cash flow; however, a long-term cash-flow deficit will spell trouble for your business and its viability.
A cash flow statement can also help the company decide:
Timing of payment cycles.
Correctly timing payment runs can have a significant impact on cash flow. Scheduling payments after cash collections/ receipt of payments will reduce the requirement to dip into savings or overdrafts and ensure you maximise early payment bonus/ rebates etc.
Monitoring aged debtor reports will aid in cash flow management. The account receivable function is key to cash flow management.

Divesting into more lucrative income streams.
Some sources of income are more lucrative than others, be that because the cost of sales is lower or because it attracts a higher margin. Choosing to increase capacity in this activity, will increase productivity and can increase cash flow in the medium / long term.

Capital Expenditure
Subject to cash flow availability, investing in new or more advanced equipment, especially for production and manufacturing companies, can lead to increased production and reduced downtime. A cash flow statement is an effective tool for planning capital expenditure.