How to be a Cash Flow Champion?

Cash flow is the lifeblood of all the businesses. For your small business, it’s the revenue (invoices) coming in and expenses (utilities, staff, contractors, rent and other costs) going out. In many organisations, there is a time lag between paying the expenses and collecting the cash generated from sales; this is where understanding cash flow is critical.  

"Never take your eyes off the cash flow because it’s the lifeblood of business"

~Sir Richard Branson

The Cash Flow Statement portrays how a company has spent its cash. It is ordinarily used in combination with the other two key reports – the Profit and Loss (P& L) and the Balance Sheet which assist you to stay informed about how your business is operating and enables you to make intelligent decisions related to operations and activities, from increasing staffing to financing growth.

The P& L statement should not be confused with the cash flow statement. The P&L statement is prepared under accrual accounting concept which requires businesses to record revenues and expenses as they occur, rather than recording these only when cash changes hands. This, coupled with the fact that accounting profit is dependent on a company’s choice of accounting policies, creates an imprecise picture of a company’s cash posture and believe it or not you can be out of cash while your business is very profitable.

"We were always focused on our profit and loss statement. But cash flow was not a regularly discussed topic. It was as if we were driving along, watching only the speedometer, when in fact we were running out of gas."

~ Michael Dell

Your cash flow statement plays an essential role in helping you develop your cash flow forecast. For example, if a particular period is consistently problematic (such as year-end or your quiet season) build that into your projections and, again, take steps to alleviate any impact well ahead of time. If your cash flow forecast indicates a shortage of liquidity anytime soon, then you need to act as quickly as possible.

A cash flow statements are made up of three distinct sections of cash flows:

1.  Operating

2.  Investing

3.  Financing

The three sections of activities are segregated to make the information presented in the Cash flow statement more useful for the reader.

Operating cash flows

These arise from the standard, day-to-day operations of a business. For example, sweet shops operating cash flows would include the cash received from selling the sweets, then the wages of the delivery driver, the funds paid for supplies and rent, and so forth.

Investing cash flows 

These are the monies expended and received from the purchase and sale of the infrastructure necessary to run the business — in the example of the sweet shop, the purchase of a sweet's making the machine and the sale of a delivery vehicle. For the most part, cash flows arising from the more traditional types of investing activities, such as the purchase and sale of debt and equity securities, are also included in investing cash flows. Investing activities would consist of the acquisition or disposal of property, plant and equipment

Financing cash flows

The sweet shop’s financing cash flows are the monies expended and received with creditors and owners other than those of an operating nature — for example, taking out a bank loan or the payment of dividends to the owner. Financing activities would include the following: dividends paid ;changes in demand loans; changes in term loans; and issue or redemption of share capital.

Importance of Cash Flow Statement

To sustain and grow, your business should have more inflows than outflows at a given amount of time as positive cash flow tells you and the investors that the company can produce a sufficient cash flow from operations to finance the business growth without the need for additional financing.

Many businesses tend to pay their sources such as suppliers and wait till customers pay them for the goods/services, this can create the problem of low cash flow. Business cannot operate robustly if outgoings are higher than incomings as this leads to negative cash flows, which coupled with the pressure of economic uncertainty, can be the straw that breaks the camel’s back, causing cash flow to collapse and the business to be in trouble. 

Cash flow supplies potential lenders with a picture of your business’s financial capacity to pay back a loan.

Your lender will verify whether your business will bring in enough money to cover the costs of any prevailing financial obligations, as well as the cost of a new loan. With business growth, the cash flow should exceed the amount needed to pay your debts as you should be utilising some of that cash flow (the excess) to fund your business growth without having to borrow.

Of all the key factors that lenders consider such as credit history, capital, collateral, cash flow (or capacity) and character— operating cash flows are regularly one of the primary considerations , if cash-flow forecasts indicate that a business won’t be able to pay back the loan, then there’s no deal. It’s one of the prime reasons that loans are denied.

This situation might force the small business owner to decide to either attempt to obtain predatory interest-bearing loans and other financial pitfalls or sell investment or properties, fixed assets to raise cash to meet the day-to-day operations of the company. 

90% of business failures are due to poor cash flow management-Dun & Bradstreet

Thus, monitoring the cash flow is very crucial for any company. Applying sufficient foresight to the business plan can keep the cash flow statement healthy when times get tough.

Ways to improve Cash Flows

 Having positive cash flows creates more flexibility for the company to decide on what to do with the cash – retain it for a rainy day, use it to buy-back shares to enhance earnings per share, or to pay some of it out as dividends to reward shareholders.

• In your cash flow statement, look for things that can give you a cash infusion, such as collecting on outstanding accounts receivable.
• Delayed payments are one of the most severe problems for any business. You should review your credit policy for more timely accounts receivable collection. For example, consider changing your invoice due-date terms from 30 days to 15 days. You can also factor your invoice to a factoring agency and get the cash upfront after paying a set amount of fees.
• Develop and implement good collection plans and make sure your staff is trained to collect payments on time while still keeping a good relationship with your customers.  
• Offer easy payment options to your customers giving them the ability to pay online or over the telephone. Giving a discount for early payment can encourage your customers to pay their bills quicker. 
• Use cloud accounting software which facilitates electronic payment and billing techniques to save mailing time costs to reduce your cheque float time, thereby shortening your collection period and improving cash flow.
• Review your accounts payable. Be sure to pay on time, but don’t get into a cash crunch by paying early unless your vendors offer terms that make it profitable to pay the bills early. Many vendors and suppliers provide financial incentives or discounts for early payment. Negotiate your payment terms so that they align with your collection terms, and structure your payment strategy to maximise discounts.
• Review your current and planned inventory purchases. Be sure not to hold up too much cash in slow-moving inventory. Optimise your order cycles and quantities by taking advantage of beneficial pricing, or reducing the amount of inventory stocked.
• Budget your inflows and outflows as this is the best way of managing the cash flow. Always have an estimate of the cost involved in the purchases of raw materials, a budget for salary payment and count the regular fixed cost of the business.

Although many small business owners don’t prefer the idea of going into debt, small business loans and lines of credit play a pivotal role in growth and success. The problem comes when business owners don’t figure out their needs and prepare for the application process in advance.

Cash flow statements and forecasts can help you analyse your business’s financial needs and research loan or line-of-credit options. You can contact lenders to learn about eligibility criteria and application requirements and gather and organise your paperwork. Also, keep in mind that for most seasonally related financial needs, shorter-term loans like lines of credit are typically preferable to longer-term /loans.

An excellent tool for this is the various cloud accounting platforms which allow bank feeds to be automatically activated and flowing into your file. You can know your cash position daily and share this information with your whole management team.

Real-time reporting using cloud accounting has been a real difference-maker in allowing business clients and their advisors to work together to solve issues before they become huge problems. There are time savings and better business intelligence to be gained.

If you’re starting afresh with cash flow statements, forecasting and analysis, consult with your CPA to be a cash flow champion as this can help you :

• Classify your cash flows into operating, investing and financing activities and prepare a cash flow statement to give you a better understanding about your cash flows.
• Analyse your data and discuss the warning signs to observe, so you can predict when times will be tough and can mitigate the negative cash flow risk pro actively.
• Plan on whether to reinvest in the business or take an additional salary from the business when cash flow is useful to reward yourself for your hard work.
• Plan in in order to save taxes which will improve your cash flows. 

The information provided on this page is intended to contain general information. The data does not take into account your situation and is not designed to be used without consultation from accounting and financial professionals. Cloudiverse CPAs will not be held liable for any problems that arise from the usage of the information provided on this page.