Cash flow management

Regardless of what you sell – whether it's services or products – cash flow management is often the difference between whether your business sinks or sails. Cash flow management is the most critical part of running a company - and yet nearly 50% of small business owners told us they don’t have an updated cash flow forecast.  Getting a handle on cash flow can have a huge impact on your business.

Cash flow management is the process of tracking the amount of money you have coming in and going out of your business. It enables you to monitor and adjust your cash receipts and expenses. After all, a healthy cash flow means the business can pay suppliers and employees on time and have funds available for future growth and expansion.

What is cash flow?

Cash flow is the movement of money in and out of your business. Cash comes in from customers who purchase your goods or services. Then cash goes out of the company through business expenses such as supplier payments, employee salaries, rent for office premises, taxes, and monthly loan payments. To calculate your net cash flow, you need to add up all cash payments over a specific period and subtract from your cash receipts. While your turnover may look impressive, it's the cash flow that offers a more accurate insight into how well your business is doing.

Why is cash flow important to a small business?

Cash flow management is crucial to building a healthy business is your route to sustainably growing your business.

For small businesses, keeping on top of your cash flow is important for helping you:

• Make informed decisions: When you have an accurate cash flow statement, you can know the exact amount of money the business has available at any given time. This means you can make better plans and more informed decisions based on the latest information.
• Know where your business is spending money: You must know where your business's money goes to understand how your business is doing and where you can cut costs.
• Protect your business relationships and reputation: If your business experiences cash flow problems, you may not be able to pay your suppliers. This can be detrimental to your business relationship and your reputation in the business community.
• Expand at the right time: It can take a lot of cash to grow a business. When you’re properly managing your cash flow, you'll know when the time is right to expand your business.

Cash flow examples

Negative cash flow

Negative cash flow happens when more money is coming out of your business account than coming in. This leaves your business short of cash to cover its expenses. It's not uncommon for a business to experience negative cash flow, for example, during periods of expansion where a business loan may temporarily cap potential earnings. Seasonal businesses may experience periods of negative cash flow before periods of positive cash flow. However, whatever the reason behind it, negative cash flow is usually a cause for concern.

Negative cash flow example: Your business receives £20,000 in revenue, but it has £30,000 worth of expenses during the same period. This deficit of £10,000 is negative cash flow.

Positive cash flow

Positive cash flow is when more money comes into your business than goes out during a specific period. You are making enough money to cover expenses and invest in your business's growth.

Positive cash flow example: Your business receives £100.000 in revenue, and in the same period, it had £30,000 worth of expenses going out. After covering all its financial obligations, your business has £70,000 leftover in cash.

Essential Cash flow Management KPIs

Given how broad the idea of cash flow is, there are a number of views you can take that yield different insights. Here are some of the most important cash flow management KPIs you should track:

Operating Cash Flow

Operating cash flow measures the cash generated by your core business operations. It indicates how well your business can generate sufficient cash to maintain and expand operations. This KPI is crucial for understanding your business’s ability to cover operating expenses without relying on external financing.

Cash Flow Forecast Accuracy

This KPI tracks the accuracy of your cash flow forecasts by comparing projected cash flows against actual figures. High forecast accuracy indicates effective cash flow planning and helps you make better financial decisions. Regularly reviewing and adjusting your forecasts based on actual performance can improve this KPI over time.

Cash Conversion Cycle

The cash conversion cycle (CCC) measures the time it takes for your business to convert investments in inventory and other resources into cash flows from sales. A shorter CCC indicates a more efficient business with a faster turnaround of inventory into cash. 

The CCC is calculated by adding the days inventory outstanding (DIO) to the days sales outstanding (DSO) and subtracting the days payable outstanding (DPO).

The CCC is calculated as: CCC = DIO + DSO - DPO.

Free Cash Flow

Free cash flow (FCF) represents the cash available after accounting for capital expenditures needed to maintain or expand the asset base. It is an indicator of the financial flexibility of your business. 

Positive FCF suggests that your business generates more cash than needed for essential expenses and investments, allowing for growth, debt repayment, and shareholder dividends.

Accounts Receivable Turnover

This KPI measures how efficiently your business collects outstanding receivables. A higher accounts receivable turnover ratio indicates that your business is effective at collecting debts and converting receivables into cash. 

This ratio is calculated as: Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable.

Accounts Payable Turnover

The accounts payable turnover ratio measures how quickly your business pays its suppliers. A lower ratio may indicate that your business is taking longer to pay off its suppliers, which could impact supplier relationships and credit terms. 

This ratio is calculated as: Accounts Payable Turnover = Total Purchases / Average Accounts Payable.

‍Current Ratio

The current ratio measures your business's ability to pay off its short-term liabilities with its short-term assets. A ratio above 1 indicates that your business has more current assets than current liabilities, suggesting good short-term financial health. 

The formula is: Current Ratio = Current Assets / Current Liabilities.

Net Profit Margin

Net profit margin is the percentage of revenue left after all expenses, taxes, and costs have been deducted from total revenue. It indicates how efficiently your business is converting revenue into actual profit.

 A higher net profit margin suggests better financial health and efficient cost management. 

The formula is: Net Profit Margin = (Net Income / Total Revenue) × 100

How to increase your cash flow

If you find that your business has a negative cash flow, you keep making late or missed payments, and you're constantly juggling funds to cover payments – you should look at how you can increase your cash flow.

Ten simple ways to increase your cash flow

1. Set a budget
2. Keep accurate records
3. Review your spending regularly
4. Put credit control processes in place
5. Diversify your revenue streams
6. Make sure you have cash flow software or processes
7. Train your staff
8. Maintain good business relationships
9. Recognise the warning signs of potential problems
10. Make use of available help when you need it

Small business cash flow management

When you run a business, you need to have a firm grip on your cash flow statements. Not only do you need to understand the nature of the cash flow in and out of your business, but it's also vital if you want to maintain a good profit and enable your business to grow.

Tips for staying on top of your cash flow

• Establish a solid credit control system
• Ensure accurate sales forecasting
• Cut out any unnecessary costs and spending
• Negotiate better terms with your suppliers
• Create good stock management processes
• Don't tie up your cash
• Stay on good terms with your lenders  
• Be ready to spot the warning signs that something's wrong
• Be realistic about your business and its future

How you can improve your cash flow with iwocaPay

Get paid sooner and improve your cash flow with iwocaPay, our invoice payment tool that gives your business customers more choice. Your customers can opt to pay now via a two-step bank transfer or pay over 3 monthly payments. Either way, you get paid upfront every time, helping cash to keep coming into your business quickly.