What is cash flow and how do you manage it?

Misunderstanding cash flow and how to manage it can easily contribute to the failure of your business.

If your business lacks the cash to pay wages, rent and bills, in the best of times it will struggle to stay afloat. But combine a lack of cash with uncertainty around the economy and survival can be even more difficult.

The COVID-19 outbreak has taken businesses into one of the biggest periods of economic uncertainty in recent history. While such a unique event has made financial planning increasingly challenging, being able to forecast as best you can is paramount.

In times of change, communicating and renegotiating with suppliers, customers, lenders or investors is vital. To do that most effectively, it helps to have the clearest view possible of your cash position.

Read this article to learn more about cash flow, why it’s so important, and how to manage it to help give your business the best possible chance of success.

Cash flow is a measurement of the amount of cash that comes into and out of your business in a particular period of time.

When you have positive cash flow, you have more cash coming into your business than you have leaving it.

When you have negative cash flow, the opposite is true. A sustained period of negative cash flow can make it increasingly hard to pay your bills and cover other expenses. This is because your cash flow affects the amount of money available to fund your business’ day-to-day operations, otherwise known as working capital.

Cash is the lifeblood of any company. In its absence, any business is likely to perish.

Even an otherwise profitable business can still experience severe short-term cash flow issues – for instance, if it’s incurred expenses creating goods or delivering services while it waits to receive payment from a customer.

That’s why creating a cash flow forecast is crucial, so you know if any shortfalls in cash are likely. If they are, it’s important to either reduce spending, or find another source of funding to be able to plug the gap and keep trading.

Managing cash in times of change

When your business faces significant change, knowing you have enough cash to cover all your costs for at least a month (and ideally longer) is crucial.

In business, some change is a good thing – but only if your cash flow is flexible enough to allow you to adapt. It affects businesses of all sizes, and can arise for a number of reasons.

Right now, many businesses are struggling with the impact of COVID-19. But other issues can have a negative effect too, such as:

  • changes in consumer demand
  • losing a major customer
  • a client being late with a large invoice payment, or not paying at all
  • changes in the price of stock or raw materials
  • cheaper alternatives entering the market
  • a general downturn in trading conditions

Being able to adapt to change, however it comes about, is integral to your business’ success. This is why your cash position and understanding your cash flow is so important.

Managing cash in times of growth

If your business is growing, and your profit increasing, you may expect your cash flow to improve. In reality, however, growth often causes cash flow problems more than anything else, as it relies so heavily on cash.

But why? This is because:

  • each sale made must be funded by working capital (available cash)
  • a business must carry stock (materials and finished products) in order to grow
  • customers often receive credit and so don’t always pay for new purchases immediately

Having a clearer view of your business’ working capital puts you in a stronger position when deciding what action you need to take.

Improving your cash flow

Every business is unique. Depending on how you make money, there may be things you can do to bolster your cash position. The important thing is to be prepared and, in the face of uncertainty, to seek independent advice.

Some simple measures you can put in place might be to:

  • improve your process for chasing up debtors
  • agree payment terms in advance
  • rent rather than buy equipment or vehicles
  • take collective responsibility for improving the business’ cash position (for example, moving from having one month’s available cash, to two or three months’)

Never ignore a cash shortfall

There may come a point where your best laid plans aren’t enough to generate the cash you need. If this happens, you should address any potential shortfall in working capital before it hits the business.

Here are some suggestions for how to do it.

  • Increasing your credit: As soon as you learn of the shortfall, speak to your bank and consider whether increasing loans and/or overdrafts, as well as other forms of debt finance, could help your business.
  • Debt factoring: This is when you sell your unpaid invoices to a third party (a debt factoring company) for a cash sum. Although it does reduce the amount of money you receive, it can prove more efficient as a method of debt collection and take the stress out of getting paid.
  • Selling and leasing back assets: You could look to raise cash by selling and leasing back assets such as machinery, equipment, computers, phone systems and even office furniture. The Finance and Leasing Association (FLA) works with companies that provide these forms of finance.
  • Considering other forms of finance: You might be able to improve your working capital position by taking out other types of finance.

The benefits of a cash flow forecast

The biggest benefit is more clarity. A cash flow forecast gives you insight into the likely future state of your business. Armed with that knowledge, you can make important decisions now, before they become critical.

For example, if you identify a need for more cash to cover delays in getting paid, you’re in a position to do something about it, instead of getting taken by surprise.

There are important differences between cash flow and profit.

Cash flow is the money that flows in and out of your business throughout a given period.

Profit is whatever remains from your revenue after deducting costs. While profit is usually taken to indicate the immediate success of a business, cash flow is a very good way to determine the business’ overall health.

This is because it’s possible for a business to be profitable while having a poor cash flow. For example, for a small electronics manufacturer selling wholesale products to large companies, a late payment could result in it being unable to pay its suppliers.

Even if you have a successful product with rising sales, you could end up facing cash flow issues and, despite reaching profitability, your business might be unable to meet its financial obligations.

How to create a cash flow forecast in 4 steps

Want to know how to create a cash flow forecast for your business? Learn the four simple steps needed to build your own cash flow forecast.

Preparing a cash flow forecast Link opens in a new window

A useful article by PwC detailing the importance of cash flow forecasts and explaining how to create one in four simple steps.

How to build an Excel cash flow forecast Link opens in a new window

A tutorial explaining how to create a cash flow forecasting model in Microsoft Excel and the structure behind any cloud forecasting model.

Barclays – Conquering cash flow Link opens in a new window

How mastering cash-flow management could help boost your business and give you peace of mind. From creating a plan to useful tips and resources, here’s how to stay on top of your cash flow.

Regional support

Enter your postcode to find business support and case studies from businesses within your region. You'll be taken to our interactive map.