12 Frequently Asked Questions Answered
Business owners are sometimes confused about the difference between profit and cashflow, says GroForth CEO Sarah Daly.
Managing cashflow correctly is one of the best ways to improve your business performance. This is because when cashflow is positive, you have money available to pay your bills and keep your business running smoothly. Positive cashflow also puts you in a strong position when it comes to financing future development and growth.
On the other hand, when cashflow is weak, it can be difficult to pay staff and bills on time. Running low on cash can be a warning sign that your business is in trouble.
So, because cashflow is such a good indicator of the financial health of a business, it’s an area that accountants often focus on. Yet, in my experience, many business owners don’t fully understand cashflow and are sometimes confused about the difference between cashflow and profit. So, set out below are answers to 12 frequently asked cashflow questions.
1. What is cashflow?
cashflow refers to the money that flows in and out of your business through normal day-to-day activity. On your cashflow statement, the money that comes in (eg payments from customers) is shown as a positive number, while the money that goes out (eg payments for utilities and services) is shown as a negative.
2. Is cashflow the same as liquidity?
Liquid assets are assets that can be easily converted to cash like the money you have in your safe, cash in your bank accounts and money owed by customers that you know you can collect quickly. Cashflow can be used to measure liquidity.
3. How is cashflow different from profit?
Profit focuses on when income earned (eg when a sale is made) but cashflow focuses on when payment is received. You might invoice a customer in March but the customer does not pay until April so there is gap between when the income is earned and the payment received. Also, unlike profit, cashflow includes the money that flows out of your business (eg expenses such as the cost of sales, capital expenditure, depreciation, interest and dividends) so it is sometimes regarded as a better indicator of your company’s health because it gives a fuller picture of your business.
4. What are the different types of cashflow?
There are three types of cashflow:
- Operating eg sales
- Investing eg dividends and interest
- Financing eg loans
5. What is positive cashflow?
Positive cashflow is when you have more money coming in than going out. It means that you have sufficient cash available to pay your staff and bills on time and that you can readily finance the purchase of essential equipment. It also means that you are in a good position if you need to raise finance to expand and/or develop your business.
6. What is cashflow quality?
Cashflow quality takes into account both the factors that impact your current orders and market and customer trends that may impact your future orders. For example, if your current orders depend on a one-off large order that is unlikely to be repeated or if the value of the order does not cover the cost of servicing it, this would be ‘low quality’ whereas a reliable stream of cost-effective future orders would be high quality.
7. What does cashflow measure?
Cashflow measures how quickly assets can be converted to cash without affecting their price.
8. What do cashflow and liquidity tell investors?
Cashflow and liquidity indicate how quickly a company can meet its financial obligations.
9. What is the difference between a cashflow statement and a cashflow forecast?
A cashflow statement shows historic cashflow information. A cashflow forecast predicts future cashflow.
10. Why is cashflow management important?
Cashflow management monitors the financial health of your business and shows how much cash you need on a day-to-day basis. It can be used to work out how to reduce cash outflows as well as to ensure you can access finance for ongoing business development.
11. How can I improve cashflow?
An effective way to improve cashflow is to speed up cash inflows and slow down outflows. Here are some ways that you can do this:
- Invoice promptly
- Make it easy for your customers to pay
- Credit check new customers
- Chase money that you are owed
- Don’t hold too much stock
12. Who controls cashflow?
Technology, particularly cloud accounting, make it easier than ever to keep on top of your company’s cashflow management but financial skills are also crucial. Key players on your cashflow management team should include the people responsible for your accounts payable and accounts receivable functions. Usually, this will be either an in-house Finance department or an outsourced finance service provider like GroForth.
Cash, as they say, is king. If you have questions about cashflow or would like advice on how to improve your cashflow management, GroForth can help. Contact our cashflow management team for details.