What is cash flow and how can I improve it?

Cash flow is a term used by accountants, bookkeepers and business owners when they compare the money coming into a business with the money going out of it. In this article we flesh that out in more detail, and give you some tips for improving your cash flow to support your profitability.

 

Why cash flow matters

A healthy cash flow is the lifeline of your business. Get the timing right for receiving money into your business versus your outgoings, and you could flourish. Get it wrong, and you may falter. 

 

When you first start a business, set-up costs, building a client base, and paying off any loans required may adversely affect your cash flow. But in the long term, profitable businesses need more money coming in than going out through the ebbs and flows of the business cycle.

Cash going into your business (cash inflows) includes:

• Immediate cash sales – including credit card payments.
• Accounts receivable – when you've sent people or companies (your 'debtors') invoices to pay you in the future.
• Other income such as interest on savings (known as 'investing cash flow'), dividends, subsidies and grants.

Cash going out of your business (cash outflows) includes:

• Expenses such as rent, electricity, phone and internet, accounting fees, insurance, taxes, and day-to-day expenses.
• Accounts payable ('creditors') – when you pay money for supplies and services.
• Salaries, wages and super.
• Long-term debt repayments, including both principal and interest repayments on loans.

Assessing your cash flow

The 'cash going into your business' minus the 'money going out of your business' equals your 'cash flow position' (or your 'free cash flow' or 'net cash flow'), which you can document in a cash flow statement in your business plan. Your plan should also include a cash flow forecast for the next accounting period, to help keep you on top of how much net income you do or don't have for growth and potential investment.

 

Your operating cash flow position could be one of three outcomes:

 

1. Positive cash flow. If you consistently have positive cash flow, you can spend, invest or save your excess cash.
2. Neutral cash flow. This means you have an even amount of cash coming in and going out, but your ability to invest in growth or save money is limited.
3. Negative cash flow. This position is not necessarily bad or wrong as even profitable businesses can experience periods of negative cash flow. It simply means you may need to find cash to cover a gap in your business in the short term. You can put in your own money, find new equity from investors, or borrow money.

Improving your cash flow

Ideally, you want to plan for positive cash flow so you can grow your business and plan ahead for times when you might experience negative cash flow. If your future cash flow forecasts are in the negative space, here are eight tips you could consider:

 

1. Get a clearer view of your cash flow by separating your business income and expenses from your personal finances with a separate bank account for business.
2. Carry out regular cash flow analysis to help foresee cash flow problems and identify ways to reduce costs and increase profits.
3. Adjust your cash flow strategy and renegotiate payment terms aiming to close the gap between when you have to pay suppliers and when you receive payments.
4. Set milestone payments for major jobs rather than invoicing everything at the end.
5. Make it as convenient as possible for customers to pay you with a choice of payment methods.
6. Avoid overdue payments by agreeing payment terms up front, repeating them on invoices, and potentially charging late payments fees.
7. Plan major purchases carefully, remembering that some business items are cheaper at certain times of the financial year such as in EOFY sales.
8. If your cash flow is temporarily negative for reasons such as seasonal downturn, financing cash flow could be an option with a business loan or overdraft.