Posted on 16 October, 2019 | 3 mins
Understanding your cash flow provides an accurate measure of your business’s financial health and enables you to make quick, smart decisions that mitigate risk and support growth. We consider the ins and outs of cash flow, how cloud-based apps are helping businesses and the metrics that matter most to yours
For a small or medium-sized business (SMB), standing out in an extremely competitive crowd while laying the foundations for sustainable growth and financial stability is tough, and nigh on impossible to achieve if unable to manage cash flow. It’s the staple of a healthy business. Fortunately, the great disrupter – technology – has entered the ring to help SMBs monitor their accounts, take control of their business and inform decision making.
Long live the cash flow king
Cash flow is the lifeblood of your business. It’s the movement of funds through your accounts – the inflow and outflow of cash – and positive cash flow gives you the ability to absorb, manage and prepare for the unexpected. Effective cash flow management puts your business in a positive position for growth and requires financial discipline and the continued analysis and management of funds. A good accounting system is imperative.
Increasingly, time-poor business owners, who often lack the internal skills to implement strategic financial systems, 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, such as QuickBooks, Xero, or Sage.
These systems track income and expenses, send customised invoices and receive payments, monitor sales – and sometimes inventory – and run reports – doing the work of a small finance department. With instant access to your bank feed, you can quickly and effectively reconcile your accounts and keep your balances in check. Using business apps helps you keep an eye on your business’s financial health.
Learn more about how apps can power your money. Download our free guide.
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. Such projections are not ‘glimpses’ into the future, rather, they are educated guesses that combine and balance several factors – from debtor’s payments and payment histories, your payment history and vendor’s patience, interest earnings, service fees, and even your ability to manage expenditure.
There are several ways to measure cash flow – explained by Investopedia – and, of course, when it comes to business it’s not a matter of ‘one size fits all, 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’s 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 a 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 can be 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 cash a business has to expand.
This metric is often used internally for budgeting – to assess the efficiency of funding utilisation, for example.
5. Levered cash flow
Levered cash flow refers to the free money a business has left after fulfilling its debts – i.e. 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, and SMBs would be wise to pay due attention to it. 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.