Balancing incomings and outgoings can be tough as a small business owner. Yet managing the flow of funds into and out of your business is crucial for growth and resilience.
“Businesses cannot operate effectively without cash, which makes managing cash flow perhaps your single most important monetary responsibility, and potentially the difference between your business thriving and failing,” says John Edwards, Chief Executive Officer of The Institute of Financial Accountants.
Here’s a look at what is cash flow and how you can manage it more effectively to support your business.
What is cash flow?
Cash flow refers to the incomings and outgoings of cash that represent the operating activities of your business. Think of cash flow as a picture of your bank account over time. If more money comes into your account than goes out, your cash flow is positive. If more goes out than comes in, it’s negative.
Why is cash flow important?
A business can be profitable but have poor cash flow. For example, if you sell products to large companies it is common to have long payment terms. This can mean a lengthy delay in the time between making a sale and the revenue being received in your account. In the meantime, you may have suppliers and salaries to pay, office costs and other expenses and if the money isn’t in your account, you can’t meet these obligations.
Effective management of cash flow can reduce the likelihood of this happening by ensuring there’s always enough cash in your business bank account to meet short-term expenses, such as wages and office overheads.
What is the difference between profit and cash flow?
Cash flow is the money that moves into and out of your business bank account over time.
Conversely, profit is the amount of cash that remains in your account from your sales revenue, after all costs and expenses have been deducted.
Analysing your cash flow
Analysing your cash flow will help you to spot trends in cash management, such as invoices that are regularly paid late. This can help to reduce the risk of negative cash flow. Your cash flow statement should form the heart of this analysis.
What is a cash flow statement?
A cash flow statement shows how much cash enters and leaves your business over a given period of time. It enables you to spot patterns in your cash flow that might affect the financial health of your business.
Types of cash flow
A cash flow statement covers three main activities of your business:
- Operating activities: These are regular business activities. Inflows of cash include revenue from sales, interest and any dividends you receive. Outflows include operating expenses like wages and office costs.
- Investing activities: This refers to monies made or lost through investments. For example, money made through the sale of assets such as land, buildings or equipment and payments for the purchase of land, buildings or other investment assets.
- Financial activities: This refers to raising money from debt or shares and repaying that debt. For example, inflows might be money you’ve borrowed, and outflows can be dividend payments or servicing debt.
What is a cash flow forecast?
A cash flow forecast estimates the cash position of your business in the future. It includes your projected income, expected costs and expenses, and estimated outgoings. This reveals whether you need to cut expenses or fight hard for extra sales to maintain positive cash flow. You’ll also be able to see if delayed payments from clients often cause cash shortfalls. You can learn more and create your own forecast with our cash flow forecast template.
A cash flow forecast should be updated regularly says Edwards. “For example, an SME with a lot of clients making small transactions might choose to complete a forecast on a monthly basis with a weekly adjustment, whereas a manufacturer delivering goods on a contractual basis with a three-month lead time may opt to establish a quarterly forecast with a monthly update.”
How to calculate cash flow
The net cash flow of your business is the total cash received minus the total amount spent over a given period. It includes cash received from all your business activities, including operating activities, investing activities and financial activities.
Net cash flow = net cash inflows - total cash outflows
For example, imagine a business earnt £50,000 from operating activities and £10,000 from financing activities. It lost £20,000 from investments. The company’s net cash flow for the period is: 50,000 + 10,000 - 20,000 = 40,000
What is negative cash flow?
Negative cash flow arises when more money leaves your business bank account than comes in, leaving you short of cash to meet your expenses. But it isn’t always cause for concern, says Edwards. “There will be periods in your business’s ongoing operation when it will need to exhibit negative cash flow, for instance during expansion where a loan may temporarily cap the potential earnings of a market,” he says. Seasonal businesses may also have periods of negative cash flow prior to periods of positive cash flow.
Example of negative cash flow
Imagine a company received £20,000 in revenue in June. But it had £30,000 of expenses. That leaves a deficit of £10,000.
What is positive cash flow?
Positive cash flow means more money is coming into your business than going out. It means you’re making enough money to cover your expenses.
Example of cash flow positive
Imagine a company received £100,000 in revenue in June and it had £30,000 of expenses. The company has £70,000 leftover in cash after meeting all its financial obligations.
What is a good cash flow?
A company is generally considered to be financially healthy if it consistently brings in more cash than it spends.
One way to gauge how strong your cash flow is, is to calculate the operating cash flow ratio. This reveals a company’s ability to repay its debts and interest. The operating cash flow ratio formula is:
Operating cash flow ratio = cash flow from operations / current liabilities
Your cash flow from operations can be found on your cash flow statement. Current liabilities include short-term debts and accounts payable. A ratio of less than 1 can indicate short-term cash flow issues and a ratio higher than 1 suggests good financial health.
How to improve cash flow
Some easy ways to improve your cash flow include negotiating shorter payment periods with clients, automating reminders for late invoice payments and cutting back on unnecessary expenses.
Maintaining cash flow is crucial for business resilience and growth. But it’s normal to have months when unexpected expenses arise or invoices are paid late. With an American Express® Business Gold Card, you have up to 54 days to clear your Card balance1, so you can keep your money in your business for longer and pay your expenses when it best suits you.
1. The maximum payment period on purchases is 54 calendar days and is obtained only if you spend on the first day of the new statement period and repay the balance in full on the due date. The American Express Business Gold Card has an annual fee of £125 (£0 in first year).