Understanding Cash Flow

The Importance of Cash Flow Forecasting

If your cash flow is negative, it’s only a matter of time before you’re out of money to pay wages, bills, and taxes. On the flip side, making a profit doesn’t mean you won’t run out of money either. 

For this reason, cash flow forecasting is critical for keeping your business afloat and helps by allowing you to predict your future outgoings and incomings. 

A cash flow forecast will also come in handy when applying for funding to get your business off the ground. Funders will want to see that you understand your cash flow and have a business plan and budget. Note: this cash flow will take into account working capital and your cash conversion cycle which you must understand to manage your business.

Difference Between P&L and Cash Flow

Generally, your initial budget will be a P&L (profit and loss) style budget which excludes GST or loan payments. But cash flow, on the other hand, is impacted by things that won’t appear in your P&L. 

Whilst your P&L may show a profit, your actual cash flow may be negative after loan repayments, tax payments, shareholder drawings, and timing of cash are taken into account.

Cash Conversion Cycle

Timing of cash is not the same as the timing of invoices. Cash is dependent on when you receive payment for your services and when you pay your bills.

Examples of cash conversion interruptions:

• Not getting paid until the 20th of the following month.
• You may need to purchase and hold inventory.
• Suppliers may want upfront deposits for services.
  

Again, it’s important to remember that your P&L won’t show things like GST, tax payments, or loan payments, all of which are paid for out of your available cash. We can recommend a bank account structure to help manage this.

Working Capital

When starting or purchasing a new business, there will normally be a lag between spending cash (wages, expenses, etc.) to when the first cash arrives from the customer. 

This is your working capital cycle. A detailed cash flow will help you examine this to ensure there will be enough cash to fund the business until money starts coming in from sales.

Staff Entitlements

Each payday, holiday pay is accrued for each employee. If that employee leaves you will need to pay them this as part of their final pay. This will not be in your budget. 

A smart way to prepare for this is by moving the holiday pay into a separate account each payday. If an employee leaves, the cash is there. If an employee takes holidays then you can withdraw this cash to pay them.

Scenario Planning

Once you have a budget and cash flow forecast, it’s easier to overlay scenarios and prepare for future business development.

Scenarios you might consider:

• What happens if I employ more staff? 
• If I win a large project, how much do I need to get it up and running? 
• If I add another warehouse to reduce freight and improve service, what will it do to cash?

Final Note

Cash is king. It’s an old saying but very true. Put simply, you can never go wrong by implementing the right business tools to support your budgeting and cash flow.