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Understanding cash flow for a better balance

July 29 . 3 Min Read

Standing out in an extremely competitive crowd while laying the foundations for sustainable growth and financial stability is tough. But it's nigh on impossible to achieve if unable to manage cash flow. It's the staple of a healthy business.

What is Cash flow?

Cash flow is the amount of cash or cash equivalents measures that a business receives or pays out. It provides a snapshot of the cash coming into or flowing out of a business. Cash flow can be positive or negative. This is calculated by subtracting the cash balance at the start of a period from the cash balance at the end of the period.

Cash flow management

Cash flow is the lifeblood of your business; it's the movement of funds through your accounts. Positive cash flow gives you the ability to absorb, manage and prepare for the unexpected. Effective cash flow management puts your business in a strong position for growth but requires financial discipline and the continued analysis and control of funds. A sound accounting system is imperative

Increasingly, time-poor business owners are opting for easy-to-use, easy-to-access cloud-based apps to reduce workload, reduce the time taken and reduce human error when dealing with money. You'll recognize big names such as QuickBooks, Xero, or Sage.

These systems track income and expenses, send customized invoices and receive payments, run reports, monitor sales and sometimes inventory – doing the work of a small finance department. With instant access to your bank feed, you can keep your balances in check. Using business apps helps you keep an eye on your business's financial health.

Measured accounts mean measured decisions

Cash flow is one of the most vital metrics for a business to track; an accurate cash flow projection can alert you to a potential issue before it becomes a problem. A cash flow projection combines and balances several factors, including interest earnings, service fees, your debtor's payments and payment histories.

There are many ways to measure cash flow – Investopedia provides a thorough overview – and different approaches can support different outcomes.

1. Free cash flow

Free cash flow is the available cash a company has after capital expenditure to support operations and maintain capital assets. It's one of the most common metrics used to measure a business' outgoings and incomings.

The metric is used when a business is expanding its product or service, paying off debts or undertaking other activities that add value to the business because it provides insights into the value and health of that business.

2. Cash flow from operating activities

Cash flow from operating activities indicates cash generated by a company's core business activities, such as manufacturing and selling foods or providing services. It excludes long term capital expenditure or investment costs (because they may be a 'one-off').

It's a metric that's most useful for companies with many fixed assets – such as buildings and equipment – because it counts cash from the sale of goods and services and excludes long-term capital costs. Calculating cash flow from operating activities means you can discount depreciation as a non-cash expense and get a more realistic view of your cash holdings.

3. Cash flow from financing activities

Cash flow from financing activities presents the net flows of cash that are unused to fund the company. Finance activities include transactions involving debt, equity and dividends.

Because it considers the external activities that enable businesses to raise capital and pay off debts, it's often used to demonstrate a business's financial strength.

4 Unlevered cash flow

Unlevered cash flow shows available cash before taking debt and other responsibilities into account and can be used to indicate how much money a business has to expand.

This metric is often used internally for budgeting. For example, to assess the efficiency of funding utilization.

5. Levered cash flow

Levered cash flow refers to the 'free' (or available) money a business has left after fulfilling its debts – i.e. money left when all bills are paid.

It's an important metric for companies planning to take on debt as can be used to determine a business's credit record, its ability to meet debt, and spending trends. Businesses also use it to assess whether they have the resources needed to expand.

"Revenue is vanity, cash flow is sanity, but cash is king," the adage goes. Because while it looks good to have large inflows of revenue from sales, for example, profit on paper doesn't mean cash in a business and immunity to failure.

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