Cash flow: What is it and why does it matter?

15/02/2022

There is a common saying in business that “turnover is vanity, profit is sanity but cash is reality”. But what is cash flow, why does it matter and how can you improve yours? This guide explains what cash flow is and why its effective management is so crucial to success.

What is cash flow?

Cash flow refers to the movement of money in and out of your business.

Ideally a business would have a positive cash flow, where more money is coming in than going out at any given time.

Negative cash flow occurs when a business is spending more than it is bringing in within a specific timeframe.

This doesn’t necessarily mean the business is making a loss. In many cases it is the result of temporarily mismatched expenditure and income.

This is often caused by trading on credit terms and waiting long periods for payment.

How do I calculate cash flow?

How to calculate cash flow: Net cash flow = income - outgoings

To calculate your business’s net cash flow, add up all of your income and take away all of your outgoings over a set period.

One of the best ways to effectively monitor your cash flow over time is through forecasting.

A cash flow forecast is an essential piece of financial housekeeping that allows businesses to know at any given time how much cash they have available to spend or meet day-to-day commitments.

This is achieved by documenting every incoming and outgoing, and can be hugely beneficial to running a business that’s strong financially.

Here is a comprehensive guide to cash flow forecasting to help improve your financial management.

Why is cash flow important?

Cash flow problems are a leading cause of business failure. Without access to necessary working capital a business may be unable to settle its bills or take advantage of new opportunities.

What’s more important: cash flow or profit?

For a business to be successful in the long term it needs to generate profits, of course. However, focusing purely on profit and ignoring cash flow can be a risky strategy and potentially prevent your business from reaching its true potential.

Here are 5 reasons why it’s beneficial to have a firm focus on cash flow stability rather than simply gauging success based on profit:

Your cash flow position provides a clearer view of the health of your business
Cash flow is necessary to keep the business trading by ensuring you can pay employees and suppliers
A healthy cash flow sets you up for long-term success
Cash flow stability allows for sustainable growth
A strong cash flow helps to protect against future challenges

Learn more about why cash flow is more important than profit

What causes poor cash flow?

There are numerous reasons why a business might experience cash flow problems. For example:

Seasonal imbalances
Declining sales
Flawed business model
Excess stock
Undisciplined spending
A restrictive funding facility
Overtrading
Poor financial planning
Late payment and bad debt
Low gross profit margins
High overhead expenses

This blog post looks at some of the common causes of cash flow problems and how to overcome them.

How can I spot a cash flow shortage?

Identifying a cash flow shortage before it happens can be the key to improving your financial position and protecting your business. Here are the five ‘C’s to spotting a cash flow shortage.

Create a cash flow forecast
Constantly update your figures
Cover multiple scenarios
Consider variable costs
Compare predictions to real data

Learn more about each of these steps

How can I improve my cash flow?

There are a number of steps your business can take to improve your cash flow including:

Increase levels of funding
Speed up payment of invoices by ensuring you have effective credit management processes in place, and potentially offering early settlement discounts
Reduce spending
Negotiate payment extensions with suppliers
Release cash from your existing assets. This could be releasing cash tied up in your sales ledger through invoice finance solutions or by releasing cash tied up in other business assets via asset finance solutions

Across our blog and resource centre, we share numerous tips and guides with more tips on how businesses can improve their cash flow. Here are some which we think you might find useful:

When businesses face unexpected cash flow shortages, it’s often due to late payment from their own clients. It can be hard to foresee when this might happen, but invoice finance can provide a great way to protect your business and make cash flow easier to predict.

With an invoice finance facility in place, up to 90% of the value of an invoice can be released within 24 hours of issue, allowing you to be certain of how much money you’ll have coming in and when.

Use our instant quote tool to see how much you could release through invoice finance.

What else do I need to know?

Effectively managing your cash flow is an ongoing process. To get the best results, cash flow management should remain a core focus on an ongoing basis..