What is Cash Flow and Why Does it Matter?
Posted on 29th April 2016 in Cash Flow
Written by Hannah Dawson
Ultimately, maintaining a positive cash flow is the number one rule of thumb in business. - 3minute read
At the heart of any business is cash flow. In essence, cash flow is the net amount of money flowing into and out of your bank account on a daily basis. While property is all about location, business is all about cash flow, and it is the very real difference between making it or breaking it in the business world.
Positive cash flow
This indicates that a company’s liquid assets are increasing, and has the ability to reinvest in its business, such as hire more staff, acquire new stock, and make improvements to premises. It also enables a business to settle debts, return money to shareholders, pay expenses, and most importantly future-proof against any unforeseen financial pitfalls.
Cash flow is used to assess the quality of a company’s income, that is, how liquid it is, which can indicate whether the company is positioned to remain solvent. Aka, keeping the lights on!
Negative cash flow
A negative cash flow indicates that a company’s liquid assets are decreasing, and should serve as an urgent warning flag that costs need to be reduced to stay afloat. This is where small-business owners who cash flow forecast their financial future have a big advantage.
Knowing what payments are flowing into and out of your business accounts months, if not years in advance, not only allows you to manage your business better but can help to avoid the hand-to-mouth existence that so often sinks small businesses at short notice. 90% of small businesses in the UK that fail every year are taken down by cash flow problems, while in Australia, 40% are due to inadequate cash flow or high cash use. It only takes one or two late payments from a client to fall behind on your own payment obligations.
Cash flow management and business forecasting separate a good small-business owner from a great one. It might not be as rewarding as closing a big new contract or securing an influential important client, but business owners who effectively manage their cash flow gain a notable advantage in the market and stay in business longer.
Net cash flow
Should not be confused with net income (also known as net profit), which includes accounts receivable and other items for which payment has not yet been received. Accounts receivable can appear as line items in the assets portion of a company’s balance sheet, but these items do not represent completed transactions. They do not, therefore, count as cash.
Small-business owners who understand cash flow and their cash flow statement tend to make better decisions than those who focus purely on the income statement. Knowing your company’s cash situation will show you where the cash is coming from, and things you can do to better your cash position.
Ultimately, maintaining a positive cash flow is the number one rule of thumb in business. This can be easier said than done, but it largely boils down to being realistic about your business decisions and keeping three steps ahead of your bottom line.
Don’t set business aims that are unachievable, such as premature expansion plans or super high salaries. Keep referring to your business plan. If you make it effortless to do and easy to understand, you remove the barriers that will prevent you from staying on top of it. The business plan and cash flow forecast should work as one and be regularly discussed with your financial advisors. If you’re always looking ahead with regular cash flow forecasts, you will always be prepared for the future.