Business Cashflow Demystified
The Complete Cashflow Guide
Cashflow is the life blood of business. Business successfully managing cashflow is more likely going to succeed in the longer run. Poor management of cashflow will cause business disruption and even unforeseen closure. Read our complete guide on business cashflow.
Simple Tips to Increase Your Cash Flow
Cash flow refers to the amount of funds going in and out of a business within a specific timeframe. Cash flow can be rightly described as the lifeblood of every business. It is an important measure of the financial health of any business.If your business is constantly spending more than it is earning, you have a negative cash flow. Negative cash flow is a threat to any business. You can’t continue to run your business if you are unable to pay your bills for an extended period of time. That’s why extended periods of negative cash flow must be avoided. Positive cash flows are the aim of every business. To achieve this, you must take measures to drive cash inflow and reduce cash outflow. Here are five simple ways you can increase the cash flow of your business;
1. Check your expenses
Many businesses tend to focus more on the money coming in. Their error here is not realizing how much flows through the back door. Sometimes businesses are faced with big important spending projects. These include hiring, inventory, equipment, location and technology. Unexpected expenses like equipment repair and replacement can crunch cash flow in businesses. Increasing cash flow requires you to pay attention to all your expenses. You must have a rigorous process that tracks all your expenses periodically. This would equally help you to quantify your returns on all investment expenditures. In the long run, you’ll be able to make wise spending decisions that will increase cash flow.
2. Optimize Your Pricing
One useful key to maximizing cash flow is optimizing the price of your products and services. Is it possible that you are selling your products for too little or for more? Your sales may suffer if your price increase is extreme. That’s just one possibility; increase in the perceived value of your product is another possibility. Often times businesses tend to offer discounts as a quick fix to generate more cash flows. It may seem effective from the onset but would have long term effects. You have to find that mid-point that can boost your cash flow without losses in sales.
3. Give Your Customers Reasons To Pay Early
Positive cash flows come from increased revenues and fewer expenses. Late payments for goods and services tend to tie down cash. You should have a definite time-frame within which payments must be made. You can decide to give your clients small discounts for early payments. Late payments should be equally punishable. Send out reminders for overdue payments so clients can pay up. The reminder should state that fees will be charged for late payment. This will encourage customers to pay early in order to reduce costs and avoid payment increase. You, on the other hand, will have more cash for the business.
4. Inventory control
Bad stock management can lead to additional costs and cause cash flow problems. Holding too much stock in your inventory ties up your cash. This includes the initial cost of the stock and the ongoing costs of holding and maintenance. This cash could have been invested in other areas. Purchasing inventory stock generates a cash outflow. When inventory stock decreases, it is seen as cash inflow. Bad inventory control is a situation where you are buying more inventory than you’re selling. Proper control will improve your inventory turnover and reduce the cost of goods sold. The end result is a positive impact on cash flow.
5. Improve Your Marketing Strategies
Any step that can make your business improve will definitely increase cash flow. Marketing is particularly one of such steps. Positive cash flows come from increased revenues and fewer expenses. However, marketing must be focused on target customers. This is to help reduce marketing expenses. It makes no sense to spend more especially when you are trying to increase your revenue. Generate attractive content that will improve the patronage of your product. Current customers must be valued and treated as such. Respond to every phone call and enquiries so that people are interested in patronizing your business.
What Is Discounted Cash Flow
Look at it from this angle, will you not want to know the current value of future cash flows? That’s exactly what the discounted cash flow does. With the help of a discounted cash flow, you are able to calculate value of a possible annuity investment, a property acquisition, or any other fixed asset purchase. Discounted cash flow is built on the assumption that cash received today carries more value than cash receivable in the future. The reason is simple, by foregoing cash to be received for a later date prevent immediate investing of such cash. It’s only better if there will be some form of interest income for a delayed payment. It’s like this; If you are given the choice of receiving a payment of $1000 now or receiving the payment in another 11 months, which will you go for? Of course, you are likely to go with collect the $1000 now, rather than wait for an unknown payment, there are chances that you can double the $1000 if you collect it now and invest. The $1000 is worth more than a $1000 in 11 months due to the potential earning capacity it carries. There are seven steps to a discounted cash flow analysis;
1. What Are The Projections of The Financial Statements?
It will be impossible to project every item on the cash flow statements. However, what is possible and expected is a gradual forecasting from the income statement, balance sheet and the cash flow statement.In arriving at projections of the financial statements, you must give an important thought to forecasting. With a proper forecasting, you should be able to picture what a business will be worth in the future.
2. What Will Be The Free Cash Flow to Firm?
Free cash flow is the left-over cash after the business has offset all operating expenditure and capital expenditure. It is with the free cash flow that a business can expand and grow.This is the ability of a business to generate money out of existing business. By knowing what the free cash flow in the future could be, you are able to pin down the future value of the free cash.
3. Ascertaining The Discount Rate
There are ways at arriving at the discount rate but applying the concept of weighted average cost of capital seems to be the most popular. This is only possible if you are able to determine the cost of equity and the debts.For the equity, there is no actual price that it pays to the investors. This is not to say that equity does not bear a cost. The debt is the current value of debt that the business is currently paying.
4. A Calculation of The Terminal Value
Another important component of the discounted cash flow analysis is the terminal value. This is done by using the perpetuity method in order to value the company. This is achieved by considering the final year projected cash flow with the infinite growth rate, discount rate and the long term cash flow growth rate.
5. Carry Out A Sensitivity Analysis
This is the last and final stage of the discounted cash flow analysis. By looking at the changes in infinite growth rate and the weighted average cost of capital. It is pertinent that you test your DCF based on those two assumptions.
6. Make Adjustments To Valuation
This will be done for all non-core assets and liabilities which did not have a place in the free cash flow projections. Consider items such as the net debt, underfunded/overfunded pension liabilities, environmental liabilities, minority interests, investments and associates at either their market value, or estimated value.
7. Present Value Calculations
Being able to calculate the values of free cash flow to firm in line with the terminal value with help to arrive at the present value calculations
How To Manage Cash Flow For Your Business
More than anything else, businesses should be able to stay on their cashflow. With an eye on your cash flow periodically, you are able to feel the pulse of your business. The health of your business is better diagnosed with your cash flow at your fingertips. It’s a critical and essential statistics that gives you an insight into how much is coming in and going out periodically. Regardless of how serious you are about your cash flow, you are bound to have cash flow problems from time to time. It’s more of a norm rather than an exception. There will be time you will have to offset bills from your supplier and clear the salaries of your employees, and bringing in income from your customers, the gap could bring about a problem. However, there is a perfect solution to this dilemma, it’s the cash flow. In order for your business not to become another statistic, we’ll be suggesting 5 ways through which you can expertly manage your cash flow;
1.Ensure You Are Paid Fast and On Time
If not the biggest factor, then it’ll be one of the determining elements of the cash flow. The onus lies on you to take charge by closing the time lapse between invoicing and the payment.>Your invoice should not always be at the end of the month, this is more like elongating the payment timeframe. Rather than impose a payment method on your client, you can ask or research about the payment method that suits their operation.Today, businesses are making use of invoicing and payment tools such as MyBooks, you can also give this a trial to see how faster your client pays. Send reminders often until the client pays.
2.Create a Financial Cushion
There are many ways to stay on top of your cash flow problems and having a financial cushion is one. How do you do this? You will have in place enough savings that can help run your business for 3 to 6 months if your customers do not pay as scheduled.With a financial cushion in place, your business will be able to run even if your customers default on payment, while you are still expecting to be paid, you can continue to run your business. This means you need to set aside not less than 3 to 6 months savings in order to be able to run the business.You can start by saving small and grow the financial cushion fund over time. Let your savings be determines by the cash flow forecast.
3.Take a Strategic Growth Approach
Sudden apportioning of resources towards growth can lead to disruption of cash flow. If you are not careful, you will find yourself experiencing cash crunch on payday and unable to offset pending bills.No one is saying you should not take a step towards growth, what is being said is that create a forecast of what the growth will cost you in terms of finance and cash. In the process of trying to grow, you are likely to incur debt, stay on top of the timeline of repaying the loans.
4.Put an Incentive Around Paying Earlier
This could make your clients pay earlier than they have planned. Imagine giving a 5% to 2% to 5% discount on early payments, you could see a 75% increase in early payments.If you are able to incentivize early payments, there is a likelihood that you will have a favorable cash flow statement. Target those who are more hesitant about paying their bills.
5.To Lease or To Buy?
This is a question you will need to proffer answers to regularly when your business needs to buy equipment, properties and facilities. Depending on the buoyancy of your business, you may have to choose between buying or leasing. By leasing, you won’t be tying down a significant portion of your capital.The decision should also be considered when in need of technology-based equipment such as computers. In scenarios like this, you should consider the speed at which technology is evolving.There are benefits to both owning or leasing, you should make a decision based on the health of your cash flow.
What Is Business Cash Flow And Why Is It Important?
The cash flow of a business refers to the movement of funds in and out of the business. Cash flow is a vital aspect of the health of every business. While making a profit is the primary aim of every business, it is not always enough to sustain it. A business must have cash in hand to meet its expenses and to ensure its survival. The cash flow of a business is a better gauge of its financial health. It can help you predict the future success of your business. Therefore, you must start to give your business cash flow much more attention.There are two aspects of business cash flow; the cash inflow and cash outflow. This is quite contrary to many beliefs that cash flow that is just outwards. Cash outflow comprises expenses in the running of the business. This includes payments for the purchase of raw materials, labour, transport, maintenance etcetera. Cash inflow of the other hand comes from payments made by clients for goods and services sold. Royalties, commissions, and fees all generate cash inflow to businesses.
Measuring Your Cash Flow
Business cash flow is measured based on specified timeframes. Most businesses measure their cash flow on a monthly basis. Weekly and quarterly measurements are however not uncommon. The most important thing is being able to measure your cash flow at regular intervals. As a rule of thumb, it is better to look at your cash flow more often.Analyzing cash flow is quite simple as long as you keep records of all your business transactions. You compare the cash in hand at the beginning of the period and the amount at the end. At the end of the analysis, your cash flow could be positive or negative. Here is a simple explanation.
Positive Cash Flow
Your cash flow is positive when you end the period with much more cash than you began with. Let’s say you began the month with $10,000. You spent a total of $6,000 for business transactions and your customers paid $11,000 for goods and services. Your cash flow is positive because you have $15,000 at the end of the month. With positive cash flow, you can easily pay your bills, make new investments and survive unpredictable situations in business.
Why Cash Flow Is Important
It has been discovered that inadequate cash reserves are one of the major reasons businesses fail. If you are making a lot of sales and you do not have cash, your business will be unable to pay its bills. It is almost impossible for such to keep running. Here is how important cash flow is to a business;
- For future Predictions. Regular cash flow measurements give you an insight into the trends of your business. It gives you an indication of how your business will run in the coming months. Regular cash flow measurements will help you stay prepared for the future.
- For Business Stability. Having a positive cash flow puts your business in a more stable condition. You will have more buying power and protection against loan defaults or foreclosures. It indicates an ability to generate and use cash
- For Business Growth. Strong cash flow gives your business the ability to invest and grow. Rather than act in a defensive way, your business can operate proactively and strategically.
Negative Cash Flow
Negative cash flow is when the cash that leaves your business is more than the amount coming in. It means your business balance is shrinking instead of growing. This might not be an issue if you have plenty of cash in your bank account. It is an indication that if your business doesn’t become more cash flows positive, it will run out of money.One month of the negative cash flow will not necessarily affect your business. If it becomes a trend, then your business is at risk. Many startups have negative cash flows because they often have many bills to pay and few sales. It is expected that as revenue from sales increases the cash flow would turn positive. When businesses make new investments, cash flow may be negative for a while.
How To Predict Cash Flows For Your Busines
Cash flow is a vital part of any business whether it’s a multinational corporation or a start-up. As a matter of fact, over 82% of businesses fail due to a poor cash flow management and forecast. Cash flow forecast simply gives you the idea of the current financial health of your business.Business experts have identified cash flow prediction as the most important tool for any business. While a business plan consists of various items that guides a business to success, a good cash flow forecast is considered as the single piece that’s most important.A cash flow projection otherwise called a cash flow forecast or a cash flow prediction is the aspect of business that predicts your money needs in advance. All other tactics, strategies and schemes to enjoy a successful business will be nought if there is no finance to back them up.
How to accurately forecast your cash flows
Now that you have discovered the essentiality of cash flows to any business, there are tips and ways to aid your cash flow forecast.
How much money will you be generating?
Estimating how much sales you think you can make on a weekly, bi-weekly and monthly basis is the first step in your cash flow forecast. Your previous sales history is a good reference in order to achieve an accurate prediction.Consider your performance over the years and highlight the things that are likely to change. Study the sales pattern during seasons and holidays. Likewise, since every marketing effort is aimed at an increased sale, take note of your performance during promotions or advertisements.
Consider your payment terms
A business owner should be able to understand that the value of all transactions are not received immediately. The cash for some sales could be turned in over a month or based on the agreement with the customer.While retail shops receive money at the point of sale, some businesses that run trade credits do not.It is however crucial during cash flows prediction to estimate when you expect to receive the value of your sales.
How much money are you likely to spend?
Articulating how much money your business spends is important during your cash flow forecast. It is certain that these costs are both fixed and variable but it is vital to unravel them as much as you can.Rent and employee remuneration are classified as your fixed costs while expenses associated with the sale of your product are often classified as the variable cost.It is important to enumerate your bills and when they will be due. Comparing the expenses of the previous year also helps in this case.After you have critically engaged in the aforementioned tips, it’s time to put the numbers together. All you need to do is to add up your entire revenue and then deduct your expenses for whatever period you are considering – weekly, bi-weekly, monthly, quarterly or annually. It is important to note that a cash flow forecast is not static. It should be revisited and updated as the business moves forward.
How Do You Define Cash Flow Forecast?
When we talk about cash in any business, it includes everything relating to money that can be spent. Cash comprises of savings, liquid securities like money market funds and your checking account. Cash in business goes beyond coins and paper.A cash flow forecast is simply a projection of when cash will come in and go out of your business whilst also revealing what will be left in your bank account at the end of the month.The idea of the cash flow forecast is that you know how much money your business has, likewise how much money it could and should have, making it easy for you to figure out things that can be done with it.The overview of a cash flow prediction is that your business gets a clear glimpse of where you are thriving the most and where you are struggling. It plots a graph that measures your annual profit against your end-of-the year debt.While cash flow forecast has been identified as the strongest tool any business can possess, lots of managers still struggle to get it right. The cash flow process is likeable to the heartbeat of a business meaning it’s not something that should be fiddled with.
Operating Cash Flow With An Example
Make no mistake, profits are quite different from cash. As a matter of fact, a profitable enterprise can run out of cash if they fail to manage their numbers effectively aswell. This is why much emphasis is being placed on cash flow.Business expenses include inventory, purchase of equipment, repayment of debt, and expenses on other asset. What’s common in all these is that the money leaves your bank account but doesn’t get revealed in your profit and loss account.Likewise, when a sale is made to a customer on account, the amount adds up to the sale in your profit and loss statement but it stays in assets as accounts receivable until the customer makes payment.This emphasizes the importance of the projected cash flow. It is the link that connects your profit and loss projections with your projected balance sheet. The cash flows plays a complimentary role as it reconciles both the profit and the loss with the balance sheet.
Why should you do a cash flow analysis?
Since cash flow is the movement of money in and out of your business, it is important to have a full understanding of how it works to avoid unpleasant surprises.As the name implies, cash flow is never static, it covers all outgoing expenses, incoming payments, deferred payments, ROI, aswell as business variables that affect your finances.Cash flow goes beyond having cash stored up in your bank account, it dwells more on a good management to ensure the solvency of your business.A clear insight into the financial health of your business helps you effectively plan and manage any financial situation that may arise.
How does cash flow help your business?
Operating a cash flow can be helpful to your business in many ways. The ultimate advantage of a cash flow is that it helps you boost the chances of your businesses’ success. Other benefits include that a cash flow projection helps you predict cash shortages as well as surpluses.It also helps you predict helps you predict how much you expect to make in sales in a particular period – weekly, monthly, yearly and so on. TCash flows also helps you identify how much you expect to spend in terms of fixed and recurrent costs.It helps you have a comprehensive overview of your business expenses and income for specific periods as well as how change affects your business. For instance, cash flows help you measure the effects of changes in your business like hiring an employee.Determining places where you fall short and how to quickly adjust is also a major dividend of cash flows.
Cash flow examples
Every cash flow must contain formats and components of a simple cash flow statement. There are various formats of cash flows and the most popular is the direct method.
Direct cash flow method
An example of the direct cash flow method can be seen below
|Cash flow statement from John Doe business for the year ended 31st December 2015|
|CASH FLOW FROM OPERATING ACTIVVITIES||£|
|Cash receipts from customers||83,000|
|Cash paid to suppliers and employees||(56,000)|
|Cash generated from operations||27,000|
|Net cash flow from operating activities||24,800|
|CASH FLOW FROM INVESTING ACTIVITIES|
|Additions to equipment||(2500)|
|Replacement of equipment||(7,000)|
|Proceeds from equipment sales||500|
|Net cash flow from investment activities||(9,000)|
|CASH FLOW FROM FINANCING ACTIVITIES|
|Proceeds from capital contributed||3,400|
|Proceeds from loan||16,000|
|Net cash flow from financing activities||13,000|
|NET INCREASE/DECREASE IN CASH||28,800|
|Cash at the beginning of the time||2,430|
|Cash at the end of the time||31,230|
From the example above, we can deduce the following
- Cash may flow in 2 directions – either in or out of your business. The cash coming in is a positive amount while the one leaving is shown as negative amount.
- You may also note that dividends are cash pay-outs only available to shareholders in the company.
- Proceeds in the above table is simply cash received from various sources.
Similar to other financial statements, the cash flow statement is usually drawn up on a yearly basic but due to its non-static nature it can also be drawn up before the year runs to an end.