Cash flow is the movement of money through your business. It’s made up of the income, outgoings and existing cash in the business, and doesn’t include any assets or investments your business might have.Get cash flow finance
Cash flow is one of the most frequently discussed terms among SMEs. But do you know some of the key related terms, how to manage cash flow and what you need to know to reach a deep level of understanding about cash flow management?
Cash flow refers to the amount of money going in and out of a business. The inflow of cash day-to-day is usually from the sale of goods and services. Money flowing out equates to payments made to suppliers, HMRC and any other expense that a company pays from its bank account.
There are dozens of ways to improve and manage your cash flow, but in this article, we will cover some of the key primary considerations for business owners to manage cash flow. If you can get a handle on these important areas, your business will hopefully always be in a position where the amount of money coming into your business is greater than the money moving out of your business.
You might only use the services of an accountant for tax returns or ad-hoc requirements, so for many businesses, it will be on the business owner to prepare a cash flow forecast. Regular and accurate cash flow projections can signal if trouble is on the way long before it is too late to react.
The first step is to create a list of assumptions to base your forecast on. This will require you to predict the price of your regular expenses, and sometimes for this, you will need the help of your suppliers, who can advise if they plan to increase their prices in the coming months. Central to the forecast will be a projection of the growth or decline in your sales, due to seasonal changes or trading headwinds. Of course, you will need to plug in any projected salary increases, fuel, energy costs etc.
Most businesses will have a fair idea of their sales pipeline and when/if leads will turn into sales, and the sales figures for the upcoming financial year. It might be worth considering a debtor's days calculation, which is the average number of days required for a company to receive payments from its customers. If many of your customers take a widely different timeframe to pay for goods and services, you can use an average for all of them combined.
Expenses for the purposes of a cash flow statement are anything you spend money on including wages, supplier costs, rent and rates, purchase of plant and machinery, and directories remuneration. Bear in mind that you will also need to add interest payments along with insurance premiums. Start with last year’s bank statements and then try to anticipate an additional outgoing in the coming year. You will need to get an accurate view of your opening and closing financial position for next month, six months and 12 months.
Cash flow forecasts need to be reviewed often and updated to provide the most realistic reflection of your business, always based on correct assumptions. This involves stress testing your projections. If sales decrease, unexpectedly, will you still be able to cover wages and salaries? What would happen if an expensive piece of machinery needed to be replaced? Would this put you in the red?
Many small businesses find it challenging to manage cash flow. This is often a result of their inability to access financial resources. Large businesses will have a readily available source of funds for short-term needs, whereas small businesses will have to more accurately match net income or net cash to monthly outgoings, to avoid negative cash flow. In the worst-case scenario, business owners will have to dip into personal funds to cover expenses, but this should never happen to a profitable business.
Cash flow forecasts and projections can only go so far. If the market changes unexpectedly or a key customer account is lost, these forecasts are redundant. For this reason, firms suffering from temporary cash flow problems will often look to apply for a short-term business loan. However, if the issue is related to seasonal net income differences, it might make more sense to try invoice financing. But, there are many other options, including but not limited to the following if you plan to grow your business despite cash restrictions.
Sell or refinance valuable business assets
Business overdrafts can be used by businesses that have predictable dips in working capital levels
Reduce debtor days by building better contractual payment terms with customers
Use an invoice finance service, to receive invoice payments upfront before customers have paid
Set up new credit facilities as there might be lenders who could offer you better terms
A cash flow loan is a short-term business loan that helps businesses have enough cash to see them through the temporary period of a shortfall. A business owner can borrow money and repay it over time. Cash flow finance enables businesses to plug the gaps caused by supplier delays and unexpected expenses.
Cash flow lending example
Imagine your main customer is two weeks late on a quarterly account payment. Your accounts team have chased it, but no luck, and to make matters worse one of your machines has broken down. Instead of putting off the replacement of a new machine, you can apply for a cash flow loan to cover the purchase and set the payment terms to a time when you know your bank account will be healthier looking.