What is Cash Flow?
In a business context, cash flow refers to the movement of cash in and out of your business. As a rule, your business will be considered healthy if cash inflows exceed cash outflows.
Cash flow is very different to profit or accounting earnings. In his 2019 letter to shareholders, Warren Buffet provided a blunt criticism of accounting profits reported by companies. Stating that “accounting profits” provide crazy earnings numbers versus cash earnings which he referred to as “real world.”
Warren Buffett, often referred to as one of the world’s greatest investors, touches on an important point here regardless of the business size. Most investors prefer to assess a company’s performance or value based upon its cash flow statement rather than its profit & loss statement.
Why Are Cash Flow Statements Important?
Cash flow is the lifeblood of any business. No doubt you have heard the phrase “Cash is King”. Without sufficient cash flow, you cannot keep your business healthy and thriving and will most likely be going backwards.
I have heard many times from clients, “I have all this profit but no cash in the bank; WHY??”
Understanding the difference between accounting profit and cash flow in your business is critical to the success of the business.
Strong free cash flow provides excellent flexibility to any business and allows the business management to take the following actions on a timely basis when the opportunities arise:
- Mergers and Acquisitions
- Access inventory at favourable prices or terms
- Restructure your business (i.e., payout finance, rationalise workforce etc.)
- Invest in new staff or equipment for growth
- Increase dividends to business owners
If your business is constantly operating without free cash flow or breakeven, you will not be able to access these opportunities when they arise. Worse still, should trading conditions decline due to internal or external factors, you may be required to act in the short term, which may significantly impact the medium to long-term health of your business.
What Affects Your Cash Flow Statement?
The cash flow of any business will be impacted by a wide variety of factors depending on the size and the nature of your business. In our experience, the following are some key factors impacting the cash flow of a small to medium-sized business. Take a look at how you can best approach your cash flow management.
|Factor||Possible impact||Possible Corrective Action|
|Unfavourable payment terms||
|High debt levels||
|Poor performing division or product line||
Information is Key
In our experience, the key takeaway is that you must keep yourself informed regarding all aspects of your business, especially when it comes to cash flow management. It’s often too easy to “work in the business” rather than “on your business”.
To mitigate any of the cash flow issues detailed above, it is essential to have experienced advisors you can call to support you in making critical business decisions. At a minimum, these advisors would include:
- Bookkeeper – To provide accurate and timely financial reports and data for your business. Also, ensure compliance with your taxation and related compliance obligations, including GST, PAYGW, Payroll Tax, Superannuation etc. Using an external bookkeeper frees you up from this compliance burden and allows you to work on your business.
- Accountant – Provides support with creating cash flow forecasts and interpreting the data on the forecast vs actual regularly. This is critical to decision-making in your business. Your accountant will also ensure tax compliance and provide specialist advice regarding business restructuring and mitigating tax payments
- Mortgage Broker – As it becomes increasingly challenging to secure finance for small to medium businesses, you should rely on a finance broker to support you to obtain more favourable terms on your existing debt.
- Solicitor – Before signing any material contract, you should always have your legal advisor review your contract and interpret all the provisions for you so you are fully informed about the document you are signing.