“Never take your eyes off the cash flow,” says Richard Branson, founder of the Virgin Group, “because it’s the lifeblood of your business.” Whether your business is struggling or booming, managing cash flow effectively is essential to your survival — many companies that go bust are profitable but have simply run out of cash.
Even if you have a bookkeeper or accountant reviewing and reconciling your accounts, as a business owner, you should understand and regularly review your financial reports, including your cash flow statement. Without a solid understanding of it – and other key financial statements like your P&L and balance sheet - you could be in for a shock when it comes to your business’s financial position.
Our guide to understanding cash flow statements will explain what cash flow is, how to read and interpret a cash flow statement, and how the way you manage your cash flow affects your business.
What is cash flow?
Cash flow is all the money moving into and out of your business. It’s different to other accounting measures as it only considers the movement of cash – it doesn’t reflect non-cash activity such as sales and purchases on credit until the associated money has changed hands. In other words, your accounts receivable and accounts payable are not reflected in your cash flow statement.
Managing your cash flow is one of the most essential elements of running your business. Understanding when you’re expecting money to flow in and out will allow you to spot and manage potential cash flow issues before they emerge and make informed decisions about budgeting and spending.
It doesn’t matter how great your product or business idea is, how meticulously you’ve worked on your business plan or how smooth your operations are - if you can’t manage your cash flow, your business won’t survive.
What is a cash flow statement?
A cash flow statemnet is a critical financial report and one of the most valuable tools for managing your business effectively. It allows you to identify regular payment cycles, seasonal trends, and situations where you might need additional cash to cover your expenses.
The Australian Business Government website has a helpful cash flow statement template and a detailed breakdown of what to include that you can download and edit.
Why is cash flow so important?
Lack of cash is one of the most common factors driving insolvency - an unexpected shortage can mean the end for a company that’s profitable on an ongoing basis.
Managing your cash flow can be especially challenging when you’re starting a business, as you’re likely to have a lot of start-up expenses that may not be balanced out by sales. Likewise, seasonal businesses who have an influx of customers at certain times offset by quieter periods need to manage their cash flow closely to ensure their cash reserves last them throughout the year.
If your business is cash flow positive, that means you have more cash coming in than flowing out. If you’re cash flow negative, your outgoings exceed the cash coming in.
Your net operating cash flow is the amount of cash that your business has left after paying its bills. If your net operating cash flow is less than your profit after tax, you’re spending more than you earn. You may need to change things up or seek additional funding.
What is a cash flow analysis?
A cash flow analysis allows you to assess your business’s financial health to determine certain cash flow patterns and potential issues. If your net operating cash flow is increasing each reporting period, this means your cash reserves are growing, and your business is likely to be healthy. If your cash reserves are declining, you might find it hard to pay off debts and become increasingly reliant on credit. If your cash flow analysis shows a consistently negative cash flow, you may need to revisit your business plan.
How can I improve my cash flow?
Invoice quickly and set clear payment terms. The sooner you send an invoice, the faster you get paid. You should also be clear on your credit terms and ensure you enforce them - you might even consider charging a fee for late payments.
Encourage face-to-face payments. When your customers pay on the spot, you save time preparing and issuing invoices and improve your cash flow at the same time. Mobile payments tools like Square Reader let you accept chip and contactless cards, Apple Pay and Google Pay securely anywhere.
Use online invoicing. Online invoicing with a solution like Square Invoices lets you send invoices in seconds, directly from your computer or point-of-sale app. With Square Invoices, you can track payment status, send reminders and accept payments, all in real time.
Create a solid, long-term forecast. A detailed view of your expected income and expenses will allow you to identify and address any potential cash shortages before they happen.
Avoid non-essential spending. Examine your planned expenses to see if there’s any spending you can delay or avoid altogether. Try to do this at least quarterly or whenever you’re considering a significant purchase.
While financial reporting can be daunting to the inexperienced, understanding key financial statements like your cash flow, profit and loss (P&L) and balance sheet is essential if you’re a business owner. Regardless of whether you have an accountant looking after your day-to-day financials and reporting requirements, having a solid command of your financial position allows you to stay in control and make informed business decisions.