Understanding Cash Flow: Your Comprehensive Guide

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You'd be hard-pressed to find an Australian business owner who’d disagree that cash flow is the lifeblood of their operation, making effective cash flow management a critical aspect of running a successful business. Positive cash flow enhances your company's ability to meet its financial obligations, invest in growth and weather unexpected challenges. 

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At Bonerath & Co., we are passionate about helping businesses of all sizes and scale to effectively manage their cash flow, which is why we're excited to present our Guide on Understanding Business Cash Flow. 

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Below, we unpack the different components of cash flow, rehash its vital importance, impart some of our top tips to keeping your business cash flow liquid and show you where to find your cash flow statement in Xero. 

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1. Introduction to cash flow

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Understanding cash flow

Cash flow refers to the movement of money into and out of your business over a specific period. It's not just about how much money you make or whether your business is profitable, it’s about the amount and timing of what you collect and spend. Positive cash flow occurs when your inflows (cash receipts) exceed your outflows (cash payments), while negative cash flow indicates the opposite.

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Importance of cash flow

We probably don't need to harp on about the importance of cash flow, but as a quick recap, it is essential for:

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• Paying employees and suppliers.
• Covering operational expenses.
• Investing in new equipment or technology.
• Expanding your business.
• Repaying loans and servicing debts.

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2. Why positive cash flow is crucial

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While the saying "cash is king!" might sound like a cliché in today's world, it remains a fundamental principle that forms the foundation of any successful business model. While achieving a year-end profit is undoubtedly positive, it's crucial to recognise that without vigilant cash flow management, the longevity of a business could be at risk even before the year concludes.

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What truly matters is effective cash flow management, which bolsters the enterprise's overall financial well-being. Neglecting scrutiny of your cash-related figures can lead to rapid and undesirable outcomes.

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A business can achieve substantial revenues and significant profits, yet struggle with inadequate cash flow. In simpler terms, the business might show profits on its financial statements at the close of a given period but possess limited accessible funds to support its day-to-day operational requirements throughout that same period.

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Combating negative cash flow 

Various factors can contribute to negative cash flow, including inadequate sales, delayed invoice payments, or ineffective cost management. To address these challenges, it's crucial to adopt a comprehensive and forward-looking strategy aimed at enhancing the company's overall cash position.

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3. Profit vs cash flow 

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Speaking of year-end profit, let's examine the difference between profit and cash flow. To truly grasp the distinction between generating profit and managing cash flow, it's essential to delve into the meanings of these two terms. 

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What is profit? 

Profit represents the surplus from your income after settling expenses, supplier invoices, taxes, etc. It emerges from cultivating a profit margin and creating value through your products and/or services. Put simply, profit = revenue - expenses

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The difference between profit and cash flow 

As a concept, cash flow involves the ongoing process of ensuring that your business maintains accessible cash (also known as 'liquid' cash) required for operational continuity. This liquidity facilitates all of the business needs mentioned above, such as trading, supplier payments, payroll coverage, raw material procurement, and other essential financial activities.

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However, profit, on the other hand, is typically only assessed at the end of the fiscal period. It isn't an ongoing process in itself — instead, the intended result of all of your business processes combined. 

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4. Components of cash flow

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Three main components play an important role in analysing a firm's cash flow. 

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Operating Activities

These involve the day-to-day business operations. Cash flows from operating activities include revenue from sales, payments received from customers, and payments to suppliers and employees.

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Investing Activities

Investing activities relate to buying or selling assets that will impact your business's long-term performance. Cash flows from investing activities include purchasing or selling property, equipment, investments, and other assets.

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Financing Activities

Obtaining finance to fund your business operations and growth is an example of a financing activity. Financing activities also include cash flows from issuing or repurchasing stock, borrowing money as well as repaying loans.

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5. Cash flow Analysis

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Cash flow Statement

This statement summarises your company's cash inflows and outflows over a specific period. It consists of three sections: Operating Activities, Investing Activities, and Financing Activities. Regularly analysing this statement helps you understand how cash is being generated and used in your business. More than this, it can help identify seasonal trends, payment cycles and help predict any cash shortages or surpluses. 

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Ratios for cash flow Analysis

Some of the most commonly used ratios for analysing cash flow are: 

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Operating Cash Flow Ratio: Operating Cash flow / Current Liabilities

This ratio shows your company's ability to cover short-term obligations using its operating cash flow.

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Cash flow to Debt Ratio: Operating Cash Flow / Total Debt

Indicates how well your business can cover its debts using its cash flow.

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Cash Ratio: Cash and Cash Equivalents / Current Liabilities 

This ratio reveals whether your business can cover its short-term liabilities with its readily available cash.

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6. Where to find your cash flow statement in Xero 

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Within Xero, your cash flow statement is called The Statement of Cash Flows. You can access the report by:

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• Selecting 'reports' in the 'accounting' menu.
• Opening the Statement of Cash Flows - Direct Method report. 
• From here, you'll need to select your required date range. (Note, you can also use the dropdown arrow to set a reporting period). 
• Select any other options that you'd like the report to show. 
• Click update. 

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7. Our top tips for managing cash flow and retaining some liquidity in your business 

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Forecasting cash flow

Cash flow forecasting is a financial management technique used to predict and estimate the inflows and outflows of cash within a business or individual's finances over a specific period of time. It involves projecting how much money will be coming into the organisation (inflows) and how much money will be going out (outflows) during a given timeframe, usually monthly or quarterly.

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• Estimate future sales and expenses.
• Consider seasonal fluctuations and industry trends.
• Plan for one-time expenditures.

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Improving cash flow

There are many different strategies that your business can adopt to help improve cash flow: 

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• Invoice management: Send invoices promptly and follow up on overdue payments.
• Inventory control: Avoid overstocking and excess inventory.
• Expense management: Identify and reduce unnecessary expenses.
• Negotiate terms: Negotiate longer payment terms with suppliers.
• Offer discounts or late payment fees: Encourage early payments with discounts or late payment fees to customers.

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Dealing with cash flow Challenges

Understandably, there will be times in most business' lifetimes where they face cash flow challenges. While challenges aren't always in a business owner's control (think the COVID-19 pandemic), there are some ways that business owners can help prepare to tackle cash flow challenges. 

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• Have an emergency fund: Maintaining a reserve fund for unexpected expenses can be a good backup or buffer for challenging times. This could be as simple as maintaining a higher cash balance in your business account. 
• Reducing expenses: Review your expenses to identify areas where you can cut costs without sacrificing essential operations. Look for non-essential expenses that can be temporarily reduced or eliminated. Negotiate with suppliers for better terms or discounts, and explore ways to optimise inventory management to free up cash.
• Prioritise payments: Ensure essential obligations like salaries and taxes are met first.

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8. Tools and Resources

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It always pays to have reliable tools and resources when running a business. 

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Accounting software 

Using accounting software can offer several benefits to a business when managing its cash flow. With real-time updates, accounting software such as Xero can provide accurate insights into your business's financial health to enable informed decision-making. Automated features simplify tasks like invoicing, expense tracking, and reconciliation, reducing manual errors and saving time. 

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Integration with banks and third-party apps enhances data accuracy and efficiency, and comprehensive reporting tools help analyse performance trends and plan for growth. (Not to mention that security measures safeguard sensitive financial information). 

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Business advisers and accountants?

Expert guidance can make or break your business's success. Consulting with business advisers and accountants who specialise in business advisory can ensure that you're receiving objective advice, support and guidance on cash flow management, tax implications and more. 

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At Bonerath & Co., we're perfectly positioned to assist your business succeed at effective cash flow management. As Xero-certified advisers, we take care of everything Xero related, from set-up to support. We leverage Xero's capability with our experience and expertise in business advisory ‍to provide a tailored solution that helps you achieve extraordinary success. 

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Take the first step to better cash flow management; reach out to the team at Bonerath & Co. today! 

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