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Managing your money

Cashflow SOS: What is cashflow? And why is it important?

Cashflow management is a critical part of running a business, during normal times and exceptional ones. But in between the daily tasks of running a business, your cash situation can go overlooked, especially when you’re under pressure.

In the light of the current crisis, we thought it was time to uncover the fundamentals of cashflow and take things back to basics. Even in difficult times, there are steps you can take to protect your business. Your cashflow is the place to start.

What is cashflow?

Cashflow is all about the money flowing in and out of your business. If the cash coming in is greater than the cash going out, your business is probably in good financial health.

Take Colin’s Cycles, a fictional bike shop – when its owner Colin has enough cash, he can pay his staff, his creditors and himself on time, keeping the business afloat. Colin was allowed to keep his shop open during lockdown, so cash might move through the business in the following ways:

Cash in: Colin mainly earns money through selling and repairing bikes. Most of his customers still buy in-store, but he’s had more online purchases in recent weeks. Colin’s bank has just approved his loan application and has transferred him the full amount.

Cash out: Colin uses the money he earns to pay suppliers, staff and his own salary, along with a range of overheads, loan payments and taxes. Colin has previously used funding to invest in new equipment, but is using this loan to make up for lost revenue.

Good cashflow should not be confused with profit, which is the surplus you’re left with at the end of the period, or with ‘having money in the bank’.

How is cashflow measured?

When companies look at cashflow in more detail, they generally talk about it in terms of operating, investing and financing activities. Here’s a quick rundown of what that means in practice, through the lens of a neighbourhood cafe:

Operating cashflow: Cash received or spent through a company’s main business activities, like selling coffee, sandwiches and cakes.

Investing cashflow: Cash received or spent through investing activities, like assets such as new kitchen appliances or investments in other business ventures.

Financing cashflow: Cash received through debt or paid out as debt repayment, such as a business loan.

Accounting software has made the process of tracking cashflow easier, by keeping a record of all your transactions online. Whether transactions are entered manually or automatically, the end result is a pool of financial data which reveals your business’ cash situation.

This information can be used to create a cashflow statement – a summary of operating, investing and financing activities – which provides a sense of how well you’re managing your cash. By looking at inflows and outflows across a certain period, you can see precisely where cash has been generated and where cash has been spent.

What businesses are most affected by cashflow issues?

In sectors where costs are high and margins are low, like manufacturing, catering and construction, cashflow issues are more commonplace. But with most businesses closed as part of lockdown measures, the playing field has been levelled somewhat.

Businesses that rely on in-person custom like pubs and restaurants, with less scope to move online, have been especially hard hit. In less challenging times, key areas which can cause cashflow to dip include:

  • Late payments
  • Seasonal demand
  • Fluctuating cost of materials
  • Poor tax planning
  • Too much stock

Ultimately, cashflow issues come back to money in and money out. Or in other terms, what you get paid and what you pay others.

What steps can I take to improve cashflow?

We’ll dive into more detail in the next article in this series, particularly around cashflow planning, but here are the golden rules to end with:

Nail your record-keeping: The key to planning is accurate, up-to-date figures. Reconcile at least twice a week, to get the clearest picture of your cash situation and make the most of your accounting software.

Control cash coming in: Whether it’s chasing late payers or improving your own processes, make it as easy as possible to get paid. Invest in recurring payments solutions, invoice finance and debtor chasing tools.

Control cash coming out: Slow things down if you can, in a way that keeps suppliers happy. This means maintaining strong supplier relationships and if you’re able to, negotiating more favourable payment terms.

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