Understanding Business Cash Flow

Somebody once said to me profit is just a matter of opinion, it’s something your accountant puts together for you when they put your financials together but cash is real, cash is king!

I totally believe cash is the lifeblood of your business and understanding how cash flows through your business is one of those key skills every business owner needs to learn. So, let the learning begin.

Where does it actually come from, or how do we actually know what cash flow is? A good place to start is to go into where cash can hide in our business. Cash can get caught up in the process of our business, and we can and need to find ways to free it.

Just knowing what’s sitting in of your bank account isn’t enough (cash position). What we really want to know is how it flows through your business.

The first thing to find out is where does all my cash come from (cash inflows)? This could be from cash sales, particularly if you’re a retailer: you take cash or credit card payments over the counter and the cash goes directly into your bank account.

You might be in a situation where you give people invoices so you don’t get your cash straight away. People in this situation end up with debtors, which is someone who has to pay you later, also called accounts receivable. You might also have some other sources of income, or other sources of cash coming into your bank account.

You need to work out where all your cash inflows come from. Once you’ve got your cash inflows sorted, then you’ll need to start thinking about where you are spending your money (cash outflow).

This includes everyday expenses like paying your suppliers, often called accounts payable, or you might just have your general expenses like paying your rent, your insurance, other consumables in your business. You may be employing people so you will also have salaries and wages to pay.

You may have loans, so you’re going to have loan repayments that you’ve got to make. And there can be all kinds of other payments you have to make in your business. It’s important that you start to write all this down, and if you write them all down and you take those cash outflows away from the cash inflows, what you end up with your overall cash position.

Now your ending cash position can have 3 different outcomes.

You may end up with a positive cash flow, which means after every cycle of your business you have more cash in your bank account than you started with. That’s a great outcome because it gives you ample opportunities to either spend that money on the growth of your business, or maybe you could save that money and put it aside for a rainy day.

Or maybe pay done some debt. Positive cash flow allows you to capitalise on these opportunities.

The second thing that might happen to your cash is you just a neutral cash flow position. Now a neutral cashflow situation is still great, you just don’t have the same opportunities as if you have a positive cash flow, but what it does mean is you’re covering all your outgoings. So you’re not going to run out of cash.

You may also have a negative cash flow, and if your cash flow is negative, it doesn’t necessarily mean it’s bad for you. It just means that at the moment you’re spending more cash than the cash coming in. and it may just be a timing difference. But if you do have a negative cash flow, you need to work out how you’re going to cover it.

Now you can cover it by putting in your own money, so if you’ve got your money lying around that you can put in, you can put into your business to cover that negative cash flow. You might get some new equity from other investors, take on a partner in your business, or you may need to go to a bank to borrow the money to fill that gap.

Now as I said, a negative cash flow isn’t always a bad thing for your business.

It doesn’t necessarily mean you’re not profitable, but what it does mean is at some point you’re going to have to make that positive, because the money you borrowed you’re going to have to pay it back.

Or your investors are going to expect a return on their money at some point, or maybe you’ll even want to some cash out of your business at some point. So you’ll need to work on your business to work out how you’re going to turn that negative cash flow back into a positive at some point in the future (the sooner the better).

A great tool to use is a cash budget. It’s a great way to put everything together: you set out when you expect your income and payments to happen in each month of the year. Have a talk to your bookkeeper or accountant to help you set this up at least on a monthly level. You could even do it on a weekly basis.

The cash budget is a great monitoring tool, however to work out where your cash is hiding, you need to understand how those in/out flows work, and a great way to do that is a concept called the Working Capital Cycle which is something I cover in more detail in the post on Optimising Business Cash Flow.

One of the questions that quite often comes up from business owners after I’ve been through this with them is, “I know where cash is hiding, but how do I go about improving my cash flow?”

Let’s look at the 3 areas where cash can be hiding.

That is in stock, in your work in progress and your debtors, to help give you some ideas about of how you can improve your cash flow.

First up, let’s look at a business that deals with inventory or stock.

You could think of your stock as being in a big swimming pool (stock pool). An interesting thing here is I see most business owners are doing everything they can to speed up their sales, so if you’ve got a stock issue, I’m going to suggest the issue isn’t just how fast you move stock out, but also look at your purchasing activities, i.e. how you bring stock in.

Also perhaps have a look at the product mix. Have a look at what types of things you’re selling (product range) or what stock are fast moving, what are slow-moving, and then set up a system to manage this.

Some of us are in service businesses and we don’t have stock. What we have is work in progress. One of the big things here is over-capacity. If I’ve got too much capacity, it’s like having too much stock.

Some questions to ask are:

  • Do I have enough jobs for the number of people I’ve got?
  • Are my sales going well?
  • Is my marketing effective?
  • Am I making sure that the people I do service work for are referring me to other people or giving me testimonials about my business?
  • Can I get them to pay me upfront for the work I’m going to do?

It’s about getting your capacity levels right and jobs completed. It’s not just about keeping everybody busy, it’s also about keeping them productive and keeping them efficient.

So how fast are they actually putting the customer’s work through? Because the faster they input it through, the faster you’re going to get your cash back.

And for those of you who have debtors and want to improve cash flow, start reviewing your credit policy. Does your policy have all of the terms you want? Set criteria’s and check who you going to extend credit to.

Is it 15 days or 30 days? When debts are not paid, what is this dispute resolution process if they don’t agree with the invoice? Are you going to put penalty payments on if they don’t pay on time, and are these penalties spelled out in your policy?

Today what we have done is we’ve had a look at what is cash flow in your business and talked about putting together a cash flow budget.

We started to talk about where cash hides, we briefly looked at the working capital cycle so you can see how the cash flows through and where is it hiding in your business.

And we’ve looked at some of the solutions that could help you improve your cash flow going forward. Your next steps are to get your cash flow under control. The best way to do that is to start out by doing a cash flow budget.

Here’s What To Do Next…

If you’re not really sure what’s involved in growing your business to secure your cashflow…

…or if you’re planning for your business exit and want to know what the opportunities and risks are, and how to maximise your business’s value while still enjoying your lifestyle, I can help.

Each month I hold a small number of Start Scale Sale Reviews designed to help you grow your business with your exit in mind, while ensuring you can take advantage of your opportunities while minimising your risks.

Join me for a complementary and obligation-free Start Scale Sale Review where we’ll:

  • Do a complete analysis of your current position. To get you started, we’ll sit down together and look at your overall financial position, talk about your goals, and look at the potential your business has to grow so it becomes very attractive to a buyer. We’ll look at ways you can maximise your opportunities and minimise your risks. We’ll explain everything for you so it all makes sense, and you’ll know exactly where you stand when we’re done.
  • Explore your options. Based on our analysis of your current situation, we’ll outline your options for growing and ultimately exiting your business. We’ll also highlight ways you can grow and secure your personal income and your overall wealth, while paying as little tax as possible. Having an impartial expert help you get everything set up on a solid foundation can help you identify the best opportunities, and prepare for or avoid any risks, which can significantly improve your financial position and build a business that enhances your way of life.

Please Note: Your review will not just be a thinly veiled sales presentation. You will be provided with actionable ideas for growing your business with exiting in mind, regardless of whether we decide to work together or not.

If we believe we can help you even further, you may be invited to become a client, but your decision to work with us or not will be completely up to you.

So if you’d like to register for a complementary and obligation-free Start Scale Sale Review to discuss how to make the most out of starting or buying your own business, even if you are just a little bit curious, let us know by using this contact form or call us on us on 1300 740 066 and we’ll set up an appointment to meet with you.

I’m truly looking forward to meeting with you.

Warm regards,

James Huy Vuong

Posted on 26/06/2017 in Accounting Services, Business Growth

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About the Author

James Huy Vuong the Founder of Your Accounting Partners, a Brisbane based Business support agency. Specialising in providing bookkeeping, accounting, tax and compliance, business valuation and business sales services to local small business owners. His passion for business was evident very early on at the start of his career in accounting. He embarked on an unconventional path away from the traditional position with one of the big 4 accounting firms like most aspiring young graduate in his field. He decided instead through the lure a more diverse role, more pay and a much cooler title to work with Australia largest telco as a Business Specialist. He entered the world of business management and ownership in the hospitality industry for the invaluable hands-on experience one could not get just by reading textbooks, understanding debits and credits and passing exams. Huy has also spent a good part of a decade in the financial services industry owning and managing his family business which has lead him to start Your Accounting Partners. Your Accounting Partners sets out to help time-poor, frustrated business owners do better business by partnering with business owners on their ownership journey and making it together. Your Accounting Partners specialises in hospitality, service-base & professional services businesses. His mission is to help business owners use their business to give back to the family what it takes out. When it comes to business we say "You focus on what you do best, partnering with us and we'll take care of the rest".

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