Cash flow refers to the money coming into a business from selling its products and the money it spends on all aspects of production.
Ideally, you will have more money flowing into the business than out. This will allow you to build up cash balances to deal with short-term costs – such as bills or expenses – as well as funding growth and reassuring lenders and investors about the health of your business.
Cash flow is one of the most important aspects of running any business – large or small. It is a challenge for any company and is one of the single most important reasons why many businesses fail – regardless of how good the business is. Managing cash flow therefore is vitally important in the smooth running, survival and success of a business.
Cash flow can make the difference between success and failure. Failure means insolvency. If you are insolvent then you are unable to pay your debts. We often use the term ‘bankrupt’ to describe this but strictly, only an individual can be declared bankrupt. Companies are declared as insolvent. The principle however is the same.
Cash flow should not be confused with ‘profit’ – these are two different things. Profit refers to the difference between the total revenue and total cost over a period of time. Cash flow looks at the money inflowing and out-flowing through your business over a period of time.
It is important to maintain enough cash in your business to deal with day-to-day running costs. Your aim should be to speed up the inflows and slow down the outflows wherever possible
Inflows include – payments from customers, interest from investments or loans into the business.
Outflows include – purchase of stock, wages, rents, daily operating expenses , purchase of fixed assets – PCs, machinery, office furniture, etc. loan repayments , Income tax, Corporation Tax, VAT, National Insurance contributions, etc
Here are 10 ideas to improve your cash flow situation:
1. Prepare a cash flow forecast – This means trying to plan out when costs will arise over the next year and also plan what the revenue is going to be. For a new firm, they might do this based on the market research they have conducted prior to starting in business. For an established firm, they might base their forecast revenue on what has happened to them in previous years.
2. Review Costs – it might be possible for a firm to review its costs if the cash flow forecast suggests problems. It can identify where its costs are causing it problems and try to find a way of reducing overheads or renegotiating them.
3. Bill promptly – invoicing promptly and regularly helps ensure a steadier flow of cash into the business. Negotiate regular payments across the life of any long-term contracts.
4. Avoid overtrading – don’t continue to accept orders and try to fulfill them if you don’t have enough cash or resources to do so.
5. Recover debts – chase up any debts owed to you.
6. Trim your inventory – excess inventory ties up your cash. Take the time to plan a stock reduction programme. Going forward order less stock but more frequently.
7. Renegotiate your credit limits – adjust payment dates and credit limits with your main suppliers.
8. Review pricing – If the cash flow forecast predicts problems then the firm might review its pricing. It could decide to reduce the price of some items but increase the price of others. Of course, if it increases its price, it risks demand falling and even if it reduces its price, it might not tempt more people to buy a sufficient amount of additional items to increase its revenue
9. Factoring – sell outstanding invoices to a third party, known as a factor. Factors pay some of the debt off in advance of collection.
10. Sell assets – raise cash by selling under-utilised assets and then leasing them back. However, you must sell the assets at their true price and check whether the sale will result in a profit or a loss.
If the cash flow problem is more long term, the business might have to take more drastic measures. It might, for example, try and get a loan from the bank to extend its finance in order to help it pay its debts. If it does this it must recognise that it will be adding to its costs and its liabilities – it will be charged interest and will have to repay the loan.