What Is Cash Flow and Why Is It Important? | Decorus for Sage

What Is Cash Flow and Why Is It Important?

 

what is cash flow and why is it important

Cash Flow Explained

Cash flow is the net amount of money going in and out of a business. Cash flow can be described as positive or negative, depending on whether you end a period with more money or less. It is at the root of business success. If you are earning more than you are spending, you can afford to invest further in your business.

Good cash flow gives you financial security. Most importantly, it means you can cover any necessary expenses. You can also pay back your shareholders and invest in new assets. To expand your company, you may want to invest in new software, hire additional members of staff or rent out an additional office.

You can measure your cash flow by referring to your cash flow statement. On there, you will find three types of values.

Cash Flows from Operating Activities (CFO)

These figures show daily expenses and any profit made through standard operations. Cash inflow represents the profit you have made from customers buying your products and services. In contrast, cash outflow comes in the form of purchases of supplier materials, wages, and taxes.

Cash Flows from Investing Activities (CFI)

Cash flow from investing activities consists of the purchase or sale of longer-term assets, such as equipment and property. Cash outflow can also consist of marketable securities (assets that can be liquidated quickly) such as stocks, bonds, and shares. Investing wisely is important as it ensures long-term financial security.

Cash from Financing Activities (CFF)

Thirdly, cash from financing activities is made up of debt repayments, dividend payments and any loans you have taken out. Transactions made to expand the business, such as loans, will show up as cash inflow.  In the case of debt repayments, these values will appear as cash outflow despite even though they are reducing financial obligations.

Combining these amounts will produce a sum we refer to as a ‘net change in cash’.

This value will tell you how much your cash balance has changed between two periods. You may also want to examine ‘free cash flow’ to understand your transactions. Free cash flow is calculated when capital expenditures (costs associated with buildings, equipment, and vehicles) are subtracted from operating cash flow. These figures will give you a clearer idea of how much money can be invested back into business for growth purposes.

Managing Cash Flow Effectively

To run a successful business, you must have a firm grasp on how cash flows work and how to manage it competently. If your cash flow is rising, it is a sign that you are making the right business decisions. If you are looking to boost your cash flow, there are several things you can do.

The best place to start is by creating sensible budgets. Start by reviewing your past statements to work out what your typical expenses are, then create a budget that accommodates them. In the case of start-up businesses, these amounts will need to be estimated instead. Additionally, looking at your income can be useful to understand how regularly you receive cash inflow.

Once you have calculated your budget, it is wise to check the health of your cash flow regularly. At least once a month, read through your transactions to make sure you are not going over budget. If your business strategies are having an adverse effect, consider changing your approach.

Another habit worth introducing, if you are not doing so already, is to aim to send out your invoices as soon as you can. Your customers will wait until they have received an invoice before paying, so handling this promptly can speed up the process. Late payments can be damaging as they disrupt the frequency of cash inflow. Send over your invoices in emails where you can, as sending them in the post can come with delays.

Lastly, an effective credit control process can strengthen your finances. Whilst giving customers more time to pay will earn favour with them, you must be mindful of your own finances. Avoid being too lenient as this will result in a greater amount of late payments. Similarly, stay firm on your payment policies and send reminders to minimise the chance of debts.

 

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