Cash Flow Guide To Increase Liquidity And Working Capital

Welcome to our Cash Flow Guide, which will increase liquidity and working capital for your business. Below, this guide will take you through step-by-step how business cash flow works and how to improve your cash position.

Cash Flow Definition

Let's start with a definition of "cash flow".

"Cash flow is the net balance of cash moving into and out of a business at a given time".

Therefore, you can think of it as the way that money moves through a business. Payments are received from debtors, and those are used to pay suppliers. At any given point, you can quantify the amount of money that a business has "on hand" to meet is liabilities.

Liquidity

This is a measure of how liquid the business is, i.e., how easily it can pay its bills when they fall due. Good liquidity means that a business can easily meet its obligations. Poor liquidity means that the payments required to creditors outweigh the amount of available money. Illiquid is another term for this. This situation can create cash flow problems, i.e., when a business is struggling to pay its creditors.

Liquidity is not just about how much money a company has. It can also take account of other assets that can be quickly converted to cash, e.g., debtor accounts or stock (that could be sold). There are specific actions you can take to improve cashflow for your business. Lots of suggestions are explained below.

Money Flow

The term "money flow" is commonly used interchangeably with the term "cash flow". Whilst money flow is a term more commonly used in connection with trading, it can be used to describe the movement of money through an organisation, hence it is sometimes used by business owners/managers. We prefer to refer to this as cash flow.

How Does Business Cash Flow Work?

In practice, money is constantly moving through most businesses. Creditors are being paid and customers are paying the business. Other factors may affect the amount of money in the company's bank account, e.g., the injection or withdrawal of capital. Different types of businesses are affected differently by working capital issues. For instance, if a company has quality debtors that pay quickly, it is less likely to suffer payment problems. Alternatively, a business that deals with poor-quality debtors may have a long debt turn (the time debtors take to pay).

Financial Analysis

Any summary of a company's cash position will be drawn at a particular point in time. The factors affecting that position may change immediately after the time of the snapshot. A commonly recommended practice is for businesses to produce a cash flow forecast. The forecast projects forward their cash flow position at regular, future points in time, e.g., at the end of each month for the next 6 months. Bear in mind, this may be drawn over a much shorter period if the company is struggling.

Cash flow is different from profitability. Profit is the margin over costs that products or services are sold at. Cash flow (CF) is about the timing between paying those costs and receiving the proceeds of the sale. A company can be selling profitably but the timing of payments from its customers can be out of sync with the demand to pay creditors. A business can be profitable but struggle to pay its bills. In some instances, this may be due to seasonal trading peaks. These occur when sales are concentrated in short periods. Alternatively, it may happen if a company is over-trading.

Having more money going out than coming in is called "negative cash flow". Positive cash flow is the opposite when inflow outstrips outflow.

See this related article about how to work out how much additional finance your company needs.

Cash Flow Statement

Some companies produce a cash flow statement as part of their financial accounts. This documents the inflows and outflows of cash over the period of the statement. This may give you an idea of where the major movements are and what you can change to improve the net position.

Cash Flow Improvement Plan

As part of the process of review, you might want to produce a cash flow improvement plan to set out how you will boost the working capital position of your business. Please see our free cash flow planning guide.

Overtrading

A business is said to be "overtrading" if it is taking on orders that outstrip its available cash flow. This can be due to a single large order that cannot be funded, or a series of orders. Companies that are over-trading suffer regular funding problems. This is because they cannot collect cash fast enough to meet the demand from their suppliers.

Things That Affect The Flow Of Cash

There are aspects on either side of the equation that can affect the CF of a business.

Cash Inflow

• The speed with which debtors pay.
• The volume of payments being received from debtors.

Cash Outflow

• The volume of payments required by creditors.
• The amount of time that those payments can be delayed.

Reserves

• The amount of money that the business already has on hand. This can include both cash on hand and borrowing facilities that can be used to pay creditors.