Cash Flow - Simply Put!

Introduction

In the Marstan Guide Business Finance - Simply Put!, we said that there are four key pieces of information required to provide good financial information for any business.

The first piece of information is a statement of your trading activities which records the profit or loss made by your business. (See Profit and Loss Accounts - Simply Put!)

The second piece of information is a snapshot of your financial position showing Assets, Liabilities and sources and amounts of money used by the business. (See Balance Sheets - Simply Put).

The third piece of information is a Cash Flow Statement.

What is Cash Flow?

Cash Flow is the movement of cash into or out of a business as a result of receipts from debtors, payments to creditors, drawings/salaries and cash sales.

Cash is critical to business survival and planning Cash Flow is the most important aspect of accounts preparation, whether it is for internal management use or to demonstrate how you will be able to repay funding to a lender, such as a bank. While a business can survive for a short time without sales or profits, without cash it will die. For this reason the inflow and outflow of cash need careful monitoring and management.

There are two types of cash flow documents:

1. Cash Flow Statement – this records your actual cash income and expenditure at the end of a forecast period (usually a month) and is a powerful management tool when used to forecast future months’ cash flow.
2. Cash Flow Forecast – this is an estimate of cash income and expenditure over a period of time (usually a year, broken down into 12 monthly periods) and is an essential management tool for working out budgets. The Forecast also provides a good indicator of the company’s financial health to potential investors.

What is CASH?

Cash is not only coins and notes that you can hold in your hand but also money held in your current account and any investments that can be immediately realised like short-term deposit accounts and unused bank overdrafts.

Cash is needed to:

• Pay Suppliers
• Pay Employees
• Pay Lenders interest
• Pay Investors dividends
• Pay Tax

Why do we need to manage cash flow?

Many profitable businesses run out of cash. A business needs to manage cash flow to have the right amount of cash available at the right time. There is no point in having a full order book if you do not have the cash to purchase materials or pay employees!

Managing cash flow gives advanced warning of any cash problems so a business can take steps to avoid them.

It is very important to remember that PROFIT does not equal CASH.

What is the difference between PROFIT and CASH?

Profit is when a product or service is sold for more than the cost to produce it and is assessed when the sale is made NOT when the customer pays.

Cash is generated when the inflow of cash (receipts) exceeds the outflow of cash (payments).

How do I prepare a Cash Flow Statement?

A Cash Flow Statement is a record of your actual cash income and expenditure at the end of a forecast period. The figures required for a simple monthly Cash Flow Statement are your opening cash balance and all receipts and payments for the month, i.e.

How do I prepare a Cash Flow Forecast?

A Cash Flow Forecast is an estimate of cash income and expenditure over a period of time. The information required to prepare a Cash Flow Forecast will be a combination of known costs/receipts (i.e. rent, rates, salaries, sales already agreed) and estimated costs/receipts (i.e. telephone, utilities, office supplies, anticipated sales).

In reality, costs such as leases, utilities etc. are paid quarterly, some in advance, others in arrears. It is advisable to enter the proper amount in the month payment is due.

Use pessimistic figures when calculating your estimated sales and costs. It is much better to err on the side of caution!

How does ‘Credit’ affect my cash flow?

Only cash is involved in the Cash Flow Forecast and Statement. Sales or purchases on credit do not form a part of these documents until you receive or pay actual cash.

How do I improve cash flow?

There are various ways of increasing cash flow; some of them are as follows:

• Increase operating profit by:
  • increasing sales of profitable products/services
  • maintain sales whilst decreasing costs
• Decrease Stock
• Decrease Debtors (accelerate the collection of money that people owe you)
• Increase Creditors (slow payments to others)
• Minimise borrowings or reduce the rates paid
• Reduce Tax paid by running business in a tax-efficient manner (speak to an Accountant)
• Reduce Dividend paid
• Reduce or reschedule Capital Expenditure
• Increase Financing via Share Capital and/or a Loan