Understanding cash flow for a better balance
Cash flow provides an accurate measure of your business' financial health, so you can make quick, sharp decisions that mitigate risk and support growth. We look at cash flow basics, how cloud-based apps can help you, and the metrics that matter the most.
Standing out in an extremely competitive crowd while laying the foundations for sustainable growth and financial stability is tough. But it's nearly impossible to achieve if you’re unable to manage cash flow. It's the staple of a healthy business.
What is Cash flow?
Cash flow is the amount of cash or cash equivalents measures that a business receives or pays out. It provides a snapshot of the cash coming in or flowing out of a business. Cash flow can be positive or negative. This is calculated by subtracting the cash balance at the start of a period from the cash balance at the end of the period.
Cash flow management
Cash flow is the lifeblood of your business; it's the movement of funds through your accounts. Positive cash flow gives you the ability to absorb, manage, and prepare for the unexpected. Effective cash flow management puts your business in a strong position for growth – but this requires financial discipline and the continued analysis and control of funds. A sound accounting system is imperative.
Time-poor business owners are increasingly opting for easy-to-use, cloud-based apps to cut down workload, save time, and reduce human error when dealing with money. You'll recognize big names such as QuickBooks, Xero, or Sage.
These systems track income and expenses, send customized invoices, receive payments, run reports, monitor sales, and sometimes inventory – doing the work of a small finance department. With instant access to your bank feed, you can keep your balances in check. Using business apps helps you keep an eye on the financial health of your business.
Measured accounts mean measured decisions
Cash flow is a vital metric to track; accurate cash flow projection can alert you to potential issues before it becomes a problem. An effective cash flow projection combines and balances several factors, including interest earnings, service fees, debtor payments, and payment histories.
There are many ways to measure cash flow – Investopedia provides a thorough overview. Different approaches can support different outcomes.
1. Free cash flow
Free cash flow is the available cash a company has after expenditure is made to support operations and maintain capital assets. It's one of the most common metrics used to measure a business' outgoings and incomings.
The metric is used when a business is expanding its product or service, paying off debts, or undertaking other activities that add value. It provides insights into the value and health of that business.
2. Cash flow from operating activities
Cash flow from operating activities indicates cash generated by a company's core business activities, such as manufacturing and selling foods or providing services. It excludes long-term capital expenditure or investment costs (because they may be a 'one-off').
This metric is most useful for companies with many fixed assets – such as buildings and equipment – because it counts cash from the sale of goods and services and excludes long-term capital costs. Calculating cash flow from operating activities means you can discount depreciation as a non-cash expense – and get a more realistic view of your cash holdings.
3. Cash flow from financing activities
Cash flow from financing activities presents the net flows of cash that are unused to fund the company. This type of cash flow includes transactions involving debt, equity, and dividends.
Because this metric considers external activities that enable businesses to raise capital and pay off debts, it's often used to demonstrate a business's financial strength.
4. Unlevered cash flow
Unlevered cash flow shows available cash before taking debt and other responsibilities into account and can be used to indicate how much money a business has to expand and grow.
This metric is often used internally for budgeting. For example, to assess the efficiency of funding utilization.
5. Levered cash flow
Levered cash flow refers to the 'free' (or available) money a business has left after all bills are paid.
It's an important metric for companies planning to take on debt as it can determine a business's credit record, its ability to meet debt, and overall spending trends. Businesses also use levered cash flow to assess whether they have the resources needed to expand.
"Revenue is vanity, cash flow is sanity, but cash is king," the adage goes. While it looks good to have large inflows of revenue from sales, profit on paper doesn't mean cash in a business and immunity to failure. Following these guidelines will put you on a balanced path to cash flow success.