Cash management is a core part of running a business. It's not something you can afford to put on the backburner, but frankly, it can be a pain; distracting you from your real passion, leaving you working on your business, rather than in it.
Crazy right? So, to ensure that you are absolutely one of the success stories in 2020, we've put together our no-fuss cash flow guide. You’ll be able to manage and understand your business's cash flow regardless of how much financial knowledge you have.
We’re starting with the basics - as we all need to start there!
What are we going to cover?
1. What is cash flow?
2. Why is cash flow important?
3. How do you calculate cash flow?
4. Common cash flow issues (and solutions!)
5. How can you improve your cash flow?
6. What is free cash flow?
7. What is a cash flow statement?
8. What is a cash flow analysis?
9. What is cash flow forecasting?
10. What software can I use for cash flow management?
1. What is cash flow?
Cash flow put simply, is the movement of cash in and out of a business.
What are cash inflows and outflows?
- Cash inflows (also money in or accounts receivable) is the money coming into your business. Inflows can be generated through the sale of goods or services, money earned through investments or money borrowed.
- Cash outflows (also money out or accounts payable) is the money leaving your business: debts, expenses, bills, wages, and purchases.
Cash flow is categorized into three sections:
- Operating: Cash flow from the business’ main operations. For example, when goods are sold, services are provided and cash is gained from this.
- Investing: Cash flow from long term investments in assets, loans, and payments, such as the purchase or sale of a property.
- Financing: Cash flow with regards to how a business is funded, including investments made by the owners, investors, or the receipt or payment of bank loans.
2. Why is cash flow important?
Rather obviously, the Small Business Administration says that “inadequate cash reserves” are the top reason startups don’t succeed but the facts don’t lie, understanding cash flow is vital to the success of your business. It must be prioritized.
Cash, of course, is the fuel that keeps your business going. First off, because generating cash, at least for most, is the primary reason for having a business in the first place. And also because it's vital for ensuring that your bills, expenses, and staff are paid and that you can continue trading. Stressfully, 1 in 7 business owners have been left unable to pay employees because of cash flow issues. This equates to 2.2 million people in the UK not being paid on time.
But as well as keeping you in business, your cash flow is also there to future-proof your business. For example, if you expect a high volume of sales next month, having cash available this month will ensure you can order supplies, etc. to handle the increased demand. Cash inflows become cash outflows, so to be successful, you must make sure you’re keeping the scales tilted in the right direction. This is where most small business trip up - planning their cash flow!
Knowing this and understanding your cash flow for this month and the next will enable you to underpin any decisions with it. Making the right choices will ultimately make it more successful and result in more cash!
How do you know if your business is profitable?
You can calculate whether your business is profitable by adding up the worth of all of your assets (including your cash inflows) and subtracting your cash outflows. If the result is positive, you have positive cash flow and your business is profitable. If the result is negative, you're operating with negative cash flow and will need to investigate how to increase your profitability.
But don't panic! It's important to note that positive and negative cash flow isn’t always as they seem. We'll dive into more detail later, but don't be too alarmed if your cash flow has dipped into the negative, in certain circumstances, this is perfectly normal.
3. The cash flow formula
What is the formula for cash flow?
The formula for cash flow is cash = money in - money out. Simple as that.
Alternatively, you could calculate it by totaling the net values of your cash for a period from the three categories we mentioned in part 1:
- operating activities
- Investing activities
- Financing activities
What is the formula for cash flow from operating activities?
The formula for cash flow from operating activities is:
Operating activities = net income + non-cash expenses + changes in working capital.
- What is net income?
Net income represents the amount of money remaining after you've been paid, and made your payments. Net income is commonly referred to as your 'bottom line'. You can calculate net income using the formula: Net income = total revenue - total expenses.u
- What are non-cash expenses?
Non-cash expenses are expenses that are reported but not paid during the given period.
Examples of non-cash expenses:
- Unrealized gains and losses
- Stock-based compensation
- Provisions for future losses
- What is change in working capital?
Working capital is the cash needed for a company to operate on a daily basis. Change in working capital is the difference between the working capital of the current year compared to the working capital of the previous year.
Working capital includes:
- Accounts receivable/payable
What is the formula for cash flow from investing activities?
The formula for cash flow from investing is:
Investing activities = inflow from sale of assets/securities - purchase of assets/securities
Cash from investing is the inflows and outflows caused by the purchase and sale of securities and assets. Examples of securities and assets include:
- Purchase of property, plants, and equipment
- Acquisitions of other companies
- Receipt of sale of another business
What is the formula for cash flow from financing activities?
The formula for cash from financing activities is:
cash from financial activities = receipt of equity/debt - (cash paid as dividends + repurchase of debt/equity)
Cash from financing is a result of raised capital and the repayment of debt. Common activities included in cash flow from financing are:
- Receiving cash from issuing stock or spending cash to repurchase shares
- Payment of cash dividends
- Receiving cash from issuing debt
- Repaying debts
- Receiving cash from issuing hybrid securities, such as convertible debt
4. Common cash flow problems to avoid
Cash flow doesn’t have to be tricky and understanding it is vital for the success of your business. Below are the most common causes of confusion for small businesses, starting with a common misunderstanding...
What is the difference between profit and cash flow?
You're making a profit, but you have no cash. 'What could be going on here?' you think. Let's look at a simple example.
Imagine you’re a contractor, you do a $10,000 job. You've spent $4,000 on materials to complete the job. So, this month, despite completing the big job, you’ve spent $4,000 and not received any cash in.
But, your profit calculations count the invoice as income despite it not having been paid yet, so your profit for the month is $10,000-$4,000=$6,000. This will not reflect in your cash flow until the invoice is actually paid which in most cases, is likely to be the following month. Being able to account and run your business to this lag is VITAL. The phrase “Turnover is Vanity, Profit is Sanity but Cash is Reality” springs to mind!
Cash is the amount of money a business has access to, in real-time: money in hand, petty cash and the totals of any bank accounts. This is the net sum of your cash flow: the discrepancy between what’s coming in and what’s going out (again, remember this can be a negative value).
Profit is the financial gain (or loss) that comes from a business’s operations. Profit does not take into account whether a sale was made in cash or on credit. So, profit does not reflect the ‘real’ amount of money a business has. They're still both important metrics, telling different stories.
Other common cash flow problems (and solutions!)
Stock control, like so many things, is a careful balancing act.
Order too little stock and you won't be able to fulfill demand or act on opportunities of increased demand. Order too much and you tie up cash flow in products that will give immediate returns and will cost you in storage charges, decreasing the amount of cash available for day-to-day operations.
Hefty payment terms
52% of B2B payments are still done by Bank Transfer which means that most small businesses rely on their customers to manually make payments within the agreed payment terms.
Lengthy payment terms will leave you waiting a long time for the financial return on your work. Whilst you wait for your clients to pay, unseen bumps in the road will be eating into any cash reserves you have. Similar to the example above, if you have a great June and pay for lots of materials, but don't get paid for those jobs until August, you'll need to use cash reserves to pay for the large amounts of resources, until the money comes in.
If the worst happens, say a large piece of equipment breaks, or you have a fire in a property, you might, despite being due payments, not have the cash around to fix it yet and will need to rely on your savings. Making sure you get paid as soon as possible after completing a job enables you to replace those reserves as quickly as possible. Do you know what the average time your clients are taking to pay you? Are you being a bank for your clients? Are you paying your suppliers too quickly (which has the reverse impact?). Find out today with Futrli Flow and you can then use online tools like GoCardless to automate your cash collections and get paid quicker!
Overspending and overtrading
It's so easy to spend cash when you're trying to grow your business. Facebook ads, SEO, websites, branding are all touted as the golden bullet to business growth. But don’t be tempted unless you have it planned. A budget that is feeding your cash flow will ensure that you know how much you have available to spend and if it is not in the budget, you must add it to see the impact on your cash flow before you buy it!
Similarly, overtrading can be detrimental - yes, unbelievably you can have too many orders! If you need to purchase materials before you get paid for fulfilling a job, you can end up spending more than you have in the bank, relying on overdrafts and loans. If your invoices, then, aren't paid on time, you can end up in tricky situations where you're having to scrounge for cash, or paying your expenses late. So often the cause of brilliant businesses failing.
Seasonality has a huge effect on your cash flow, for the same reasons we've mentioned above. If you haven't had much business through February and March, but know that April is your best month, buying materials, investing in marketing and making preparations for April, you'll need to pay out a lot before seeing any returns.
If your business is reliant on particular seasons or periods in the year, working with a cash flow forecast (more on that in section 8) allows you to ensure those good months help out the not so good, by helping you plan and budget your cash accordingly.
If you are building a cash flow forecast for the first time, it does not need to be difficult. Your accountant or advisor will help you or tools like Futrli Predict will take the heavy lifting out of it using AI and machine learning to predict your cash flow.
5. How can you improve your cash flow?
Your cash flow is crucial to keeping your business on the straight and narrow. There are lots of procedures that can be put in place to encourage best practices for your cash flow management.
Encouraging payment collection
Late payments are one of the biggest problems facing today's small businesses. In a recent survey by Xero and PayPal, it was found that 48% of invoices were paid 14 days late, on average.
In real terms, this means that the average UK small business is owed £23,360 in late payments, a 17% increase on 2018!
When overdue invoices stack up, small businesses start to suffer, there just aren’t the cash reserves to continue to pay staff, suppliers, stock, etc without it coming in the top!
How to get paid quicker?
- Use Direct Debit. GoCardless will automatically collect payments for any invoice on the due date, whether recurring or ad-hoc. (GoCardless users spend 84% less time chasing unpaid invoices and 82% report improvements in their cash flow!)
- Be particular. Only take customers with good credit histories. Futrli Flow provides you with credit scoring for all of your customers. If they are in the red, don’t let them put you in the red too.
- Insure your cash! Take the worry away from invoices not being paid with Futrli Flow Invoice Protection. A nominal amount will get you paid every time even if your supplier becomes insolvent.
- Be insistent. Your customers are less likely to put off paying when they know there are strict conditions in place. Ensure you have an agreed payment date, method, and warnings of the relevant charges for late payments (important note: there are some rules around this, you can’t just rock up with a baseball bat!).
- Automate it. Automating your invoicing systems with cloud based credit control tools like Chaser can make it much easier to ensure payments are made, sending reminders to your customers and having invoices chased if they're made too late.
- Make it simple. Using tech can also give your customers a better experience with payment portals and recurring payments. The simpler the process, the more likely they are to pay on time.
- Keep payment terms tight. For new customers try and get paid in advance or take a deposit. Only extend customers into credit terms as they earn your trust. If a credit score of any customer is bad - take it all upfront.
- Know your rights. It's worth doing some research with government bodies like the Small Business Commissioner as to what to do if you need to take an unpaid invoice further. It's not a strategy to use every time, as it certainly won't help you build relationships, but when big cases strike, it's good to know your options and there is plenty of advice out there.
- Keep good records. Yes, you've heard it a thousand times, yes we're going to say it again. Keep records of all of your due invoices, bills, and expenses. If you don't have automated systems like Xero, QBO or ReceiptBank, you'll need to ensure you're collecting your payments on time to build efficient processes and set expectations for your customers.
Cut your costs
One benefit of building long-term cooperative relationships with your suppliers is being able to negotiate better deals with them, with reduced pricing or extended repayment periods. Use Futrli Flow to see your total spend with particular suppliers. You will be a customer they will be relying on their cash flow for their next year and so may be willing to reduce costs in order to keep you. It also acts as an audit, in the tech world we live in now it is very easy to be paying for online services that you no longer use, the list of suppliers in Futrli Flow will reveal this!
Other ways to reduce your costs include evaluating and reducing your expenses, innovating new ways to make the most of materials (using leftovers), consolidating your production/office space, reducing paid marketing spend (and investing in organic marketing instead), going paperless. The options are endless.
If your cash flow is a pinch point, consider the money you're investing in the financing portion of your business. Are you reinvesting a lot? Are you trying to grow too fast, or at a bad time? Review the next 12 months as predicted in your cash flow forecast, may be there is a more stable time from which to grow, use tools like Futrli Predict to see what happens to your cash flow if you delay expansion by a few months. Use data to drive decisions, not personal ambition (although a healthy portion of this goes a very long way too!).
Equipment and machinery will often require massive upfront payments, as well as payments for the maintenance that comes with them. Especially in your early days, when upfront costs are high, one option to consider is leasing.
It does work out more expensive in the long run, so we wouldn't recommend leasing everything you need, but it can be helpful for the equipment you won't need for every job or those with the biggest price tags. It also more predictable costing - there will be no hidden maintenance costs with leased equipment so when cash is tight, this helps.
Alternatively, if you still want to buy, consider purchasing refurbished equipment. It will if from a reputable source, come with a warranty, and often be brand-new, having been deemed 'unsellable' for a minor fault or scratch.
Optimize your inventory
As we mentioned earlier, buying too much stock, or having excess stock on hand can be detrimental to your cash flow. By optimizing your stock, you can ensure these issues are well avoided.
Stock optimization is also called inventory optimization. This is basically to make the stock as lean and beneficial as possible. This means that it will be optimized in such a way so that it is the ideal size, thus ensuring the supply needed for all purchases. You cannot do this without a solid cash flow forecast which has been built to account for the seasonality of your business and has accurate growth predictions.
Increase your prices
Increasing your prices can seem like a terrifying move to make, but it can work out. If your business is stable and you have regular customers, they'll likely understand a slight price increase - there's no way to know without trying.
6. What is free cash flow?
Free cash flow describes the cash a company has, after its operations, equipment, and assets have been taken care of. Where cash flow provides a snapshot of the cash going in and out of a company, free cash flow is the cash remaining.
Having largely positive free cash flow could tell you that you have money that can be reinvested back into the business, paying off your debts quicker, or getting you in the good books of potential investors.
How do you calculate free cash flow?
This simple formula is suitable for anyone or any business and is a perfectly acceptable method of working this out. (There are other more complex calcs but leave those to the analysts or investors.)
Free cash flow = cash flow from operating activities - capital expenditures.
What is capital expenditure?
Capital expenditures, more commonly known as CapEx, are funds that are used to acquire, upgrade and maintain physical assets such as property or equipment. An expense is considered to be a capital expense when it is a newly-purchased asset with a life of more than a year or an asset that extends the useful life of an existing asset.
If an asset is being expensed as a capital expenditure, the cost of the asset is spread over the useful life of the asset.
What is the formula for capital expenditure?
CapEx = PP&E (current period) - PP&E (prior period) + depreciation (current period).
PP&E - property, plant, and equipment. These are your fixed, tangible assets. They're tangible as physical assets with clear purchase value. And they're fixed because they cannot be sold or turned into cash easily, likely to provide value to a business for a long period of time.
Depreciation - An accounting method whereby the cost of an asset is spread over the asset's useful life. Not as complicated as it sounds and really valuable as it can enable you to spread out the cost of the asset which will positively impact your bottom line! There are many types of depreciation to use.
7. What is a cash flow statement?
What is a cash flow statement?
A cash flow statement provides a summary of the inflows and outflows a business has - including investments, operation costs, etc. Whilst these reports will be demanded by boards, investors and banks, it is solid business practice to use these from the beginning of any business (it is also never too late to start!).
What's included in a cash flow statement?
Cash flow statements are comprised of three sections, broken down the same way we broke down cash flow earlier:
- Operating - This is your net income, plus or minus increases in your current assets, liabilities, and expenses.
- Investing - This reflects the increases and decreases in long or fixed term assets.
- Financing - This reflects any increases or decreases in long term liabilities/debt/capital.
What is cash flow from operations?
Cash flow from operations is the first section of your cash flow statement and includes transactions from all operating activities. These activities would include things like sales, paying employees, purchasing supplies, etc.
What is cash flow from investing?
The second section of a cash flow statement, detailing investment gains and losses. This could include the sale or purchase of properties, the acquisition of other businesses, investing in new machinery.
What is cash flow from financing?
Cash flows from financing is the final section of the cash flow statement, providing an overview of cash flow concerning funding the business. This includes a business's equity, debt, and dividends.
Analysts use this section to look at where a business sits in terms of borrowed funds - if cash flow from financing is a negative number, it means the business is paying off debts, making stock buybacks or dividend payments.
What's a cash flow statement used for?
Let's look at an example. You're thinking of opening a new location - how can cash flow reporting and forecasting help?
Well, opening in a new location comes with risk - using the historical and forecasted data you have on your business will help mitigate those risks.
First, take a look at your historical data - how long did it take you to get your original location up and running? How much did it cost? Remember to take into account that some things, eg. your website, won't need to be duplicated.
And take a look at the last few months, too. Have they been consistently positive? You'll need to ensure your existing location is performing well and stable before opening another location. Then, take a look at your cash flow forecast (more on cash flow forecasting later) to see how you're going to be doing for the next few months. If they, too, look strong, you're in a position to go forward.
Ultimately, you always need to be on top of your cash flow. Whether it's recognizing issues that are slowing you down, monitoring your growth or mapping exactly where your revenue is coming from.
Say, for example, that you note that a large percentage of your revenue is dependent on one customer. Putting an initiative in place to diversify your portfolio of clients would be a recommended action.
Investors and analysts
If you decide to apply for funding, your cash flow statement, among other financial documents, will be examined. They provide a look into the health of a business and its value. They also detail if the company is generating revenue, how it's doing so, and the types of debts they have.
8. Cash flow analysis
What is a cash flow analysis?
A cash flow analysis is an investigation of a company's inflows and outflows. The analysis takes a set period and shows the movement of cash flow within that time. This is then examined, to look for trends and weak points, to inspire future strategies.
Why is cash flow analysis important?
Cash flow analysis is important to ensure you have a realistic overview of your business's cash position. Accrual accounting is the accounting method used by most companies, where revenue is reported as it's invoiced, rather than when the company receives payment. Expenses, too, are reported when they're made, rather than when they're paid.
As a result, companies using these methods will find that their cash position seems inaccurate. If a construction company completes three jobs, their income statements will say they have X amount of cash, but in reality, they won't have any of that cash (yet).
Creating a strategy based on your cash flow
Your overall business strategy should be built upon many of the factors affecting your business. Your cash flow is one of those factors, influencing when you decide to make or implement decisions for your business. Knowing where the weaknesses in your cash flow are and where they come from, will help you boost your business's performance.
My cash flow is consistently good - what next?
Although having positive cash flow is great, having too large a surplus margin could suggest that you're not investing enough money back into your business, and are therefore missing potential opportunities to grow.
What can you do with surplus cash?
- Bank it - having a cash pillow for your business to fall back on can be a great idea as well as give you great peace of mind. Using your cash flow forecast (more on that later), you may know you have some tricky junctures coming up, so make sure you have some cushioning for those lower times. High-interest accounts and bonds are also an option if you're happy to lock the cash away for a while.
- Reinvestment - reinvesting cash back into your company is a great way to grow. Bettering your assets, expanding to new locations, increasing the budgets for your teams, investing in advertising or new staff... the possibilities are endless.
- Pension plan - another option is planning for your personal future, investing some of the surplus cash as pension contributions or property.
My cash flow doesn't look good - what should I do?
Most businesses will experience this, negative cash flow is just part of business. Maybe you invested in a new piece of machinery or paid for next season’s stock. Maybe you've just had a bad month. Other times, when negative cash flow becomes a regular occurrence or appears out of the blue, it can be a sign of problems within your business. This is a warning sign to investigate the leaks in your business's bucket. Are you being paid late by customers? Where is resource being wasted? Are there any holes in your teams or processes that need plugging?
Speaking to a financial advisor can be a great way to figure out where potential issues are in your business and how to fix them.
9. Cash flow forecast
What is cash flow forecasting?
A cash flow forecast predicts your cash inflows and outflows over the coming months or years. By including what you expect to earn and what you expect to spend, a cash flow forecast makes it easy to see what your bank balance is likely to be at a particular point in the future. This will help you prepare for seasonal changes, busy and quiet periods and provide a roadmap on which you can plan your business’s journey.
What is the difference between a cash flow and a profit forecast?
A cash flow forecast is based around when income is received and when costs are paid for. A profit forecast, however, is built around when income is invoiced and when costs are incurred. As we discussed earlier, creating an invoice and being paid are two different things, happening at different times. Things like late and partial payments are not accounted for in a profit forecast but are in a cash flow forecast.
What are the benefits of cash flow forecasting?
Armed with the knowledge of what you’ll have in the bank, your cash flow forecast will allow you to make educated decisions at the right time for your business. Here are some examples of questions that cash flow could help you answer:
- Can I start creating a new product/service?
- Can I open a new office/location?
- Can I start selling in a different area/country?
- Can I afford another member of staff or outsourced assets?
- Can you take more money out of your business?
- Are you at risk of running out of cash?
How do you create a cash flow forecast?
To create a cash flow forecast:
- Select a period of time (the further into the future you look, the less accurate you can be)
- Estimate all your cash outflows: bills, expenses, salaries
- Estimate your cash inflows: sales, tax refunds, grants, investments
- Start with your opening bank balance (the cash you have right now), from there, plot when you will receive and make payments throughout your chosen period
- Use the closing cash balance of a month as the opening balance of the following and repeat the process.
Remember that cash flow forecasts are all about the timings of payments and be as accurate as possible
How far into the future should I forecast?
Forecasts are most beneficial for looking at the next year. Whilst having a 5 or 10-year forecast can be helpful when visualizing and planning the long-term expansion of your business, it’s important to remember that the further you look into the future, the less accurate your cash flow forecast will be.
Can I use software for forecasting?
Yes! In fact, we recommend that you do. Forecasting in a spreadsheet can be overly complicated and requires a lot of manual effort to create and maintain. There are many excellent online tools available, both our Predict (perfect for small businesses) and Advisor (perfect for larger businesses) tools make forecasting quick and simple. Using a cloud-based tool allows you to keep your forecasts updated without any manual effort, always ensuring you have access to the most up-to-date information. More on cash flow software next.
10. Cash flow software
What is the benefit of using cash flow software?
If you've made it to this point, hopefully, cash flow's feeling a little simpler. But, improving your cash management strategies might seem like a huge task to take on. So, it may be of comfort to know that there are a number of cash management tech solutions to help.
As many of these systems are cloud-based, they acquire data automatically, giving a number of benefits:
- Accurate, timely, up-to-date
The automatic retrieval of data eradicates the chance of human error in data input. With multiple daily syncs, Futrli ensures the data you're presented with will show you the most up-to-date version of your business. When making decisions, you need the best, most accurate data possible, to support and inform your choices.
Utilizing software unites all of your data into one place. Trawling through reports or hopping from system to system uses valuable time and makes it easy to lose track. Software like Futrli makes it simple to stay on top of everything, by bringing everything into one place.
Not only does software adoption eradicate the room for error in data input, but it eradicates the need for you to do it all! Software like Futrli pulls information from a number of integrations. For financial data, we integrate with Xero and Quickbooks, industry-leading cloud accounting software. So forget huge admin costs and man-hours, it's done for you.
What tool is right for me?
Futrli provides several tools to help you manage your cash flow. For a smaller business or those just starting out with cash flow management, we have Futrli Flow.
Flow analyses your customer and supplier data and uncovers improvements, trends, and successes in your cash management strategies. With a prioritized newsfeed, you'll be given data-driven insights and recommended actions to improve your cash flow, it's the essential start to your day.
For those with bigger, more complex businesses (or any of you hungry to really sink your teeth into your business's data), we have Futrli Advisor. Deep business reporting (including cash flow!), bespoke KPI dashboards, powerful forecasting… the list goes on. The key to running a successful business is to know three things: where you’ve been, where you are and where you’re going and Futrli Advisor will help you nail all three. Find out more here.
Both Flow and Advisor act as fantastic cash management systems (and so much more), helping you to stay ahead of the game, in control of your business and paving your way to success.