- Article
- Starting a business
- Ensure Sufficient Cashflow
What is cash flow and how do you manage it?
What is cash flow and why is it important for you small business? Understand the formula, statements, management, forecasting and the difference between cash flow and profit.
What is cash flow?
The term cash flow refers to the net balance of money that moves into and out of your business over a set period. When cash flow is said to be positive, more money is coming in than going out. When cash flow is negative, more money is being spent than received.
Why is cash flow important for your business?
Ensuring a healthy positive cash flow helps keep your business solvent. It ensures you can pay bills and wages and meet your future business objectives. Cash flow management allows you to anticipate and plan for any cash shortfalls and capitalise on spells of positive cash flow.
Know how
Cash flow formula
Net cashflow = total cash inflows – total cash outflows
Cash flow statement
A cash flow statement tracks how much money your business brought in over a set period, and how much was spent. The figure at the bottom of the statement is your total net cash flow. If it is positive, cash flow increased over the period; if it’s negative, more cash was spent than received.
Cash flow statements offer a true reflection of cash movements in your business over time. They differ from profit and loss accounts (which show profitability) and balance sheets (which provide a snapshot of your business value at a particular moment). Together, these are useful indicators of the health of your business, for you and for potential funders and investors.
How to manage your cash flow?
The proper management of cash flow helps your business pay your employees, retain suppliers, and ensure your customers get the service they expect.
Create cash flow statements and projections
Generate cash flow statements on a regular basis to ensure you can get an accurate picture of the current status of your cash flow.
Create cash flow projections which consider the likely future growth of your business as well as increases in prices such as rent, staff pay, equipment or raw materials. Projections should reflect any seasonal fluctuations in your target market and expected changes to your broader trading environment.
Calculate revenue income
Estimate how much you will bring in from sales, considering the payment periods of your customer base. For example, you many generate immediate income via the sale of goods or rely on customers to pay invoices over an extended period, typically 30 or 60 days.
Improving your cash flow
Prepare a cash flow forecast for the next three months or longer, listing the due date for any cash receipts and balancing them against planned business expenses. Identify any periods of projected negative cash flow to help plan ahead. Ensure that your bookkeeping is up to date to help create an accurate forecast and ensure that your credit control processes allow for the timely collection of payments.
Preventing cash shortfall
You can help prevent a cash flow shortfall by separating out the expenses required to ensure the daily running of your business from those required to meet your growth ambitions. This provides a stronger understanding of which cash flows are essential to business operations, and which can be cut back on in times of restricted cash flow.
Create a budget that has the flexibility to grow or shrink, depending on your cash flow situation. Include a buffer amount to cover unexpected events such as sudden price hikes, the loss of a major customer or economic turbulence.
It is also important to build up enough cash reserves to support your business through at least three to six months of operating expenses, depending on your business needs, in order to survive through volatile economic periods.
Types of cash flow
There are three main types of cash flow your business may need to cover: operating activities, investment activities and financing activities.
Cash flow from operations (CFO)
Operating activities is the cash flow generated by the production and sale of the goods or services of a business.
Cash flow from investing (CFI)
Investment activities relate to the purchase and sale of investment assets such as stocks and bonds, real estate or equipment.
Cash flow from financing (CFF)
Financing activities relate to the money used to fund a company’s activities, such as the issuing of stocks, the borrowing of money, repurchasing of shares and debt repayments.
The combined incomings and outgoings from operating, investment and financing activities are detailed on a company’s cash flow statement and used to calculate total net cash flow.
Benefits of cash flow forecasting
Effective cash flow forecasting helps businesses identify any potential cash flow challenges, stay on top of liquidity requirements, plan for future growth, and create a clear picture of the financial health of your business – so you could make informed business decisions.
Having a well-prepared cash flow forecast can help you secure financing from lenders, who use this information to assess your borrowing risk profile HSBC UK’s My Business Finances1 provides free accounting tools including invoice generation, automatic spending categorisation, estimated profit, loss and tax reports, and a single view of your finances.
Cash flow terminology | Description |
|---|---|
Free cash flow | Free cash flow (FCF) is a measure of financial performance that shows how much money the company has left over to expand the business or return to shareholders after paying dividends , buying back stock, or paying off debt. |
Unlevered Free Cash Flow | Unlevered free cash flow (ULFCF) measures the gross FCF generated by a company before taking interest payments into account. |
Cash flow to net income ratio | This is the ratio of a firm's net cash flow and net income, with an optimum goal of 1:1. |
Current liability coverage ratio | This ratio assesses the company's ability to cover its current liabilities with the cash flow from operations. |
Price to cash flow ratio | Here, the operating cash flow per share is divided by the stock price. |
Positive cash flow | Sustained positive cash flows shows your business is in good financial health. |
Negative cash flow | While negative cash flow can indicate financial challenges, it can also be a result of investment in improving operations, enhancing products or investing in growth. |
Free cash flow (FCF) | FCF represents the cash you have available after deducting operating expenses and asset purchases. Positive free cash flow can help pay off debt, remunerate stakeholders and re-invest in your business. |
Operating cash flow margin ratio | Measures cash received from sales revenue as a percentage of sales revenue from a given period. |
Cash flow to net income ratio | An important financial measure for comparing free cash flow to net income that provides a measure of the true profitability of a business. |
Price to cash flow ratio | A comparison of a company’s stock value per share against its operating cash flow. |
Examples of cash flow
Cash flow example 1
Company A
Company A receives £175,000 from a combination of sales, debt and stock issuances over a three-month period. It also expends £130,000 in expenses such as wages, capital expenditure and dept repayments.
We could calculate its cash flow as follows:
Cash inflow = £175,000
Cash outflow = £130,000
Net cash flow = £45,000
Cash flow formula
Cash inflow (£175,000) - Cash outflow (£130,000) = Net cash flow (£45,000).
Company A can be said to be in a positive cash flow situation during this period.
Cash flow example 2
Company B
Let’s say company B earns £15,000 in cash inflow in a certain period yet spends £20,000 in order to invest in developing its products and hiring crucial skilled labour.
Here’s how we would calculate its cash flow situation:
Cash inflow = £15,000
Cash outflow = £20,000
Net cash flow = £-5,000
Cash flow Formula
Cash inflow (£15,000) - Cash outflow (£20,000) = Net cash flow (£-5,000).
Company B can be said to be in a negative cash flow situation during this period. However, this is anticipated to be a temporary measure aimed at delivering long-term growth.
What is the difference between cash flow and profit?
Cash flow and profit provide different measures of the health of a business. While cash flow sets out the way money moves in and out of your business over a particular time, profit is your financial gain after deducting all your expenses from your revenue.
A business may be profitable yet struggle to maintain a healthy cash flow – for example, because creditors are slow to pay. Equally, a business might enjoy strong cash flow but miss profitability while it pays off loans.
Do businesses need to issue a cash flow statement?
Small businesses are not required to issue a cash flow statement, but potential funders or investors are likely to request one.
HSBC UK Small Business Banking Account
Open an account with us today and gain access to:
- Free banking for 12 months2
- Business borrowing solutions are also available to suit you3
For eligible startups, small businesses and switchers
Disclaimers
1. My Business Finances - You must be an HSBC UK Business Banking customer to access free accounting tools through My Business Finances. This is not available for HSBC Kinetic customers. T&Cs apply.
2. Small Business Banking Account - Free banking means no account maintenance fee and all day-to-day standard transactions are free on your primary business current account. Any additional or secondary accounts will be charged in line with the Business Price List. A full list of prices and charges can be found in our Business Price List (PDF, 377KB).
3. Borrowing is subject to application, eligibility, affordability and credit check. T&Cs, fees, charges and rates apply. For loans, you don’t need to open or maintain an HSBC Business Current Account unless a debenture or fixed charge over book and other debts is required.
