How can calculating cash flow help your business?
One of the most important aspects of running a business is understanding your company’s financial health. As a small business owner, it can be tough juggling everything but one of the most critical things you definitely need to keep an eye on is cash flow.
Why is cash flow important?
It’s essential for any business owner to track cash flow on a regular basis. That’s because it can help you identify problems and indicate if your business is financially healthy in both the short and long term. You'll be able to pick up on issues before they become a bigger problem and prevent or mitigate their effects.
Today, we’ll be exploring what cash flow is, why it matters and how to calculate it. By the end, you should have a comprehensive understanding of how to monitor and manage your cash flow to better safeguard your business’ success and stability.
What is cash flow?
Cash flow involves calculating the money moving in and out of your business. It gives you a net positive or negative number that tells you if your business is making or losing money.
A positive cash flow means you have more money coming in than going out and a negative cash flow means the opposite. Of course, we all love to see a positive cash flow but a negative one is fairly common. If it becomes a monthly pattern, you probably need more financial advice.
A negative cash flow for the odd month isn't any reason to panic. In fact, it can give you the opportunity to look at what's going wrong and work towards greater financial stability. Maybe you need to raise your prices, buy less of the stock you're struggling to shift or invest in more marketing to reach a wider audience. There are a lot of ways to diagnose and treat a negative cash flow.
By monitoring your cash flow regularly, you can identify problems early and take steps to address them.
What are the different types of cash flow?
It’s time to get a little more technical. There isn’t just one type of cash flow - there can actually be three.
Operating: Cash from day-to-day operations
Investing: Cash from investing in new assets
Financing: Cash made by borrowing money
Learning what each type is and how each one can help you in different ways can be a huge benefit to the knowledge of your own business and how it works.
What are the different parts of the cash flow formula?
To calculate cash flow, you need to understand what inflows and outflows are.
Inflows are the sources of money that come into your business such as sales revenue, loans or investments. Outflows are the opposite, including expenses, bills, loan repayments and payroll.
How do you calculate cash flow?
The cash flow formula is very simple. It's even more simple if your data is ready to access in your accounting software. If not, let us know! Our free data health check will identify if you're collecting complete and accurate data.
You use the following formula to calculate cash flow:
Cash Inflows - Cash Outflows = Cash Flow
Here’s a simple example.
Let’s say your company generates £100,000 in cash inflows as well as £75,000 in cash outflows.
To calculate your overall cash flow, you'd just have to do £100,000 - £75,000. That’s a net positive cash flow of £25,000.
For a more comprehensive output, you might want to segment your inflows and outflows.
For example, if you have £100,000 in inflows, maybe £50,000 comes from operating (e.g. revenue), £40,000 from financing (e.g. loans) and £10,000 from investing (e.g. new machines). Do the same for outflows and you’ll also be able to calculate the cash flow for each category.
How can cash flow calculations be used to help your business?
So, perhaps your operations generate a very negative cash flow on their own but because of good investments and financing, your overall cash flow looks positive overall. This can be deceptive.
Without looking at each category individually as well as overall, you might keep running your business thinking everything is going well. Let’s say one month your financing falls through… you’ll get a nasty shock when your overall cash flow takes a hit! This is easily avoidable by looking at the cash flow for each of your incoming and outgoing cash streams.
It’s important to get down to the nitty-gritty of the numbers and fully explore what’s going on. That’s why you hire an accountant like us who can do it for you and apply their expertise in a way that makes a positive impact on your cash flow.
With all this in mind, you should now be able to look deeper into your cash flow and get a clearer picture of your business' financial health.
Ready to learn more?
If you're interested in learning how to make positive changes to your cash flow on your own - read our eBook! You'll receive it over email and have access to it anytime you need some tips.
For an expert cash flow solution, give Finance Box a try. We offer a comprehensive suite of services tailored to your needs and have access to intelligent forecasting software to predict where your cash flow is going next.