The Basics of Cash Flow

Cash is the lifeblood of your business. It flows in as your customers pay for products or services, and it flows out as you make payments to suppliers.

It's vital that you manage cash flow as carefully as revenue, expenses and profits. And remember:

• Profit is not cash
  
• More businesses fail due to lack of cash than lack of profits
  
• It's all a question of timing

The difference between profit and cash

• Profit = Sales - Attributable costs
  
• Sales is the value of products or services sold during a particular period, not the cash you receive from customers.
  
• Attributable costs are the costs incurred in manufacturing and distributing the products that have been sold, not the cash you pay to suppliers or distributors.
  
• For example, goods purchased by a retail store from a wholesaler may be paid for - a cash outflow - before they’re sold and recognised as a cost. Similarly, when a sale is made, it is recorded as revenue but the actual cash inflow only happens when payment is received later on.
  

How to calculate your company's net cash flow

The importance of cash flow forecasting

• When a company experiences rapid growth in sales, cash can be tied up more quickly than it can be generated through additional profits.
  
• Without extra resources, the company’s cash balances may drop sharply, leaving it in an undesirable financial state.
  
• Cash flow forecasting gives your business:
  • A detailed forecast of expected cash receipts, payments and cash balances over a planning period
    
  • A tool to anticipate short-term borrowing needs (if there is a cash flow deficit), as well as investment opportunities (if there is a cash flow surplus)

Managing account receivables to improve cash flow

One of the most important factors in managing your company's cash is the ability to collect account receivables (debtors) quickly. Here are some ways to do this:

• Streamline the shipping-to-billing process
  
• Review credit extensions to slow-paying customers
  
• Provide incentives such as early payment discounts and delayed payment interest penalties
  
• Analyse account receivables monthly or even weekly to identify potential payment delays
  
• Accelerate cash flow by borrowing against account receivables – as well as providing instant cash the loan can be synchronised to match growth in sales and account receivables.

Managing inventory to improve cash flow

Inventory is usually considered the 'necessary evil' that affects cash flow. It is necessary because supply and demand never coincide exactly, and it is evil because it ties up cash.

• Reduce inventory - Service firms may not have much inventory apart from stationery. Manufacturers, on the other hand, have raw materials, work in progress, and finished goods. The key is to maintain adequate but not excessive inventory.
  
• Monitor inventory - don't let stock sit idle. Consider automated inventory management software for inventory identification and control.

Managing account payables to improve cash flow

Cash flow and account payables are closely linked. A payable outstanding means that you can keep cash equal to that amount in your business account. When payment is made, however, your cash balance is reduced accordingly.

• Negotiation - in certain emergency situations, you may have to ask creditors to delay payment schedules. Creditors are usually receptive to this because it is in their best interests for your company to stay afloat.
  
• Timing - in general, the longer creditors’ funds can be borrowed the better. That is, payment should be delayed as long as is acceptable by your suppliers. However, some accounts payable may have payment terms that include a cash discount. In these circumstances, paying later may not be a wise move, as the full settlement cost may exceed the original amount due to late-payment fees.

Other useful information and services

• Cash Flow Management Guide
• Payments and Cash Management
• 5 Steps to Raising Finance
• Telegraphic Transfer Exchange Rates Information