Cash flow: what is it and how do you calculate it?

To calculate your cash flow, put two amounts next to each other: the money coming into your business and the money you spend. As long as the first amount is higher than the second, you have a positive cash flow. A useful tool here is a cash flow statement and forecast. An example can be found in our free e-book on cash flow management.

As part of good cash flow management, you should create a cash flow statement. By bringing all the information together in a cash flow statement and making a forecast of future cash flow, you will be able to perform a good cash flow analysis. This creates much greater awareness of likely opportunities and potential threats. Proper record keeping is key here. This will give a clear picture of the financial position of your business, enabling you to identify problems and decide how to avoid cash flow issues. Keeping a cash buffer can also be a useful habit. A cash buffer helps in situations such as the breakdown of a major piece of equipment, or late payment/non-payment of a large invoice.

Even a profitable business can become insolvent if cash flow is disrupted. This could happen when customers fail to pay bills on time, for example. There are three common strategies you can use to improve your cash flow

1. Improving your sales margins and profitability is one possible strategy to improve your cash flow. Higher margins mean increased liquidity, provided that customers continue to pay under the current terms. Price increases can be a problem in competitive markets, so it's better to look at the sales mix first: can sales of higher-margin products be increased? Alternatively, you can add value that will justify a higher price.
2. Increasing the inventory turnover is a method widely used to cut costs and free up money for investment. Inventory build-up can be an appealing option as orders increase, but it does require capital and is therefore a risk. It is preferable to implement more efficient, just-in-time processes and inventory reduction.
3. Tight management of outstanding invoices is another method of freeing up money. For some businesses, this is the simplest. Make sure you have professional buyer management and build a relationship with the most important contact person within your customer's organisation.  Instead of waiting for an outstanding invoice to be paid, you can enter into a transparent dialogue and make agreements. You will find more tips in our article on how to deal with unpaid invoices.
   
   When it comes to protecting cash flow, choosing the right customers is also important. Before doing business with a new customer, check the customer's creditworthiness, payment performance and financial status. Also check whether your contact person is an authorised signatory.
    
4. Draw up a regular liquidity or cash flow forecast. By bringing all available information together into a cash flow statement and separately making a forecast of future cash flow, you will be able to perform a good cash flow analysis. This gives you a much greater awareness of opportunities and potential threats. It means ensuring that you keep adequate records. Take the time to keep track of your business's income and expenses and make sure the information is always up to date. Having a clear picture of your business's liquidity position will help you identify problems and decide how to avoid cash flow issues.

Even if you have good cash flow management and think you've picked the right customers to do business with, you can't avoid cash flow problems. It's just the way it happens sometimes. Fortunately there are ways to protect against cash flow problems. Our trade credit insurance, for example, can help protect your business against credit risks, ensuring its growth.