As a small business, every new sale is exciting. Watching your revenue grow is hugely rewarding, but it can be easy to get distracted by these numbers and neglect your cash flow.
Understanding the flow of money into and out of your business helps ensure you always have enough funds available to pay your bills. Even if you’re taking in lots of sales, you can still find yourself cash-strapped if the money from those sales doesn’t reach your bank account in time to meet your monthly obligations.
In this article, we speak to Nick Ford, founder of architectural engineering firm PipSqueak Developments and business mentor Christine Nicholson on why cash flow is the life-blood of any business.
Why is cash flow important?
Cash flow is defined as the amount of money entering and leaving your business over a given period of time. Cash flow is important because it enables you to meet your existing financial obligations as well as plan for the future.
Yet, cash flow is a common challenge among small businesses. Around 60% of small business owners say that cash flow has been a problem for their business and with 89% of them saying these problems have had a negative impact on their business.
By balancing your inflows and outflows of cash, you can ensure the smooth day-to-day running of your business, at the same time as building sufficient reserves to weather peaks and troughs in sales, late invoice payments or unexpected expenses.
Maintaining a steady flow of cash into and out of your business is crucial for business growth and resilience. With an American Express® Business Gold Card, you get up to 54 days to clear your balance¹. This will help you plan when it’s best to pay your business expenses so you can better manage your incomings and outgoings.
Is cash flow more important than revenue?
Let’s start by looking at the difference between revenue and cash flow. Revenue is the money your business makes from the sale of its products or services. Cash flow, on the other hand, is the movement of money into and out of your business's bank account.
In this way, revenue tells you how successful you are at selling your products or services. But cash flow shows you how much money you have available to keep your business running and invest in expansion. Without cash in the bank, you could land big orders that you can’t fulfil because you don’t have the cash reserves to pay your staff or suppliers.
“Tracking cash flow allowed us to invest in a small way in two areas that we would not have considered a year ago,” says Ford. “We were able to allocate funds to two ventures that are significantly more risk-laden than we would have considered, with the knowledge that if the worst was to happen then we can afford the risk.” This included applying for a grant through Innovate UK, and filing a patent for a “speculative development” in the food packaging industry.
Maintaining a steady cash flow puts your business in a stronger position to grow revenue. For example, a strong cash reserve enables you to expand into new markets, diversify your product offering or hire more staff.
Is cash flow more important than profit?
Profit is the amount of money left from your sales after you’ve paid your expenses, such as office rental, bills and salaries. While profit is an important metric to track, it doesn’t show you the net amount of money moving into and out of your bank account, which is crucial to keeping your business running. This means that cash flow is more important to track on a day-to-day basis, as it's cash flow that ensures your business can keep going.
To give you an example, a profitable business can have poor or even negative cash flow. This can happen if you sell to companies that pay their invoices late. In this situation, you might run out of cash to meet your monthly expenses before your sales revenue lands in your account.
Why are cash flow statements important?
Cash flow statements help you identify profitable parts of the business, spot any areas of waste and understand when and if it might be the right time to scale. By tracking his cash flow statements, Ford says he quickly recognised his company’s core architectural market was “not a good market”’ to rely on given the events of the past 18 months.
“We revived the innovation support side of the business instead, helping five clients develop designs for innovative new devices in the past 12 months,” says Ford. “Our cash flow statement showed that we had under-utilised cash reserves that were not working for us. Sitting on cash reserves is very comfortable, but not using it to fund the right expansion at the right time is just like burying it in a hole in the ground – we were being too reserved in the levels of new venture risk that we were allowing PipSqueak to undertake.”
What is the most important part of a cash flow statement?
One of the most important parts of a cash flow statement is timing. “You need to know the amount of time it takes between spending money and receiving money,” says Nicholson. This will reveal whether you have money available each month to pay your expenses and, if not, what the root causes might be so you can take action. For example, if clients are paying invoices late you could send reminders or reduce payment periods. And if you’re struggling to pay suppliers you could negotiate longer payment terms.
Why are cash flow forecasts important for a business?
Cash flow forecasts predict your future incomings and outgoings, based on your known costs and historical revenue data. You can use a cash flow forecast to understand whether you might experience a shortfall or surplus of cash in the future and use this in your decision-making. For example, if you predict a shortfall you might consider cost-trimming whereas if you predict a surplus, you can consider expansion into other markets.
“Cash flow forecasting means you can plan for bigger purchases; plan for investment and build strategic plans for future growth,” says Nicholson. She recommends forecasting at least three months ahead.
You can learn more about how to create a cash flow forecast here.
Who else sees your cash flow statement?
Nicholson recommends sharing your cash flow statement with sales and procurement teams who can use it in decision-making and for tracking performance. “Visibility on the cash flow forecast means they can understand the impact of the decisions they are making,” she says. For example, when to purchase stock, what payment terms to enter into and when payment is likely to be received. “The time between money going out and revenue coming in can often cause a profitable business to struggle with cash flow,” she says.
If you plan to raise investment or sell your company, then investors and potential buyers of your business will also be very interested in your cash flow statements, says Nicholson. Specifically, she notes that they will be looking for reassurance that they won’t be called upon to inject cash into your business just to keep it running.
Maintaining a steady flow of cash into and out of your business ensures you always have enough money available to pay your expenses and reinvest for growth. With an American Express Business Gold Card, you get up to 54 days to clear your balance¹. This helps you to better balance your incomings and outgoings. Plus, you can earn Membership Rewards® points – and use them to reinvest into your business – every time you make these payments.²
- 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 £175 (£0 in first year).
- Membership Rewards points are earned on every full £1 spent and charged, per transaction. Terms and conditions apply.
- If you'd prefer a Card with no annual fee, rewards or other features, an alternative option is available – the Basic Card.