A recent study published by Commonwealth Bank revealed that nearly 80% of Aussie small to medium businesses (SMBs) have experienced an impact to their cash flow in the last year. The research highlighted that revenue (35%), low cash reserves (30%), and seasonal fluctuations (27%) were the top factors impacting cash flow.
While the majority of businesses (approx 85%) surveyed undertook several cash flow management strategies such as decreasing their expenses, maintaining a cash reserve, sourcing additional revenue streams, and increasing pricing, these efforts came at a cost. About 27% of businesses dipped into their personal savings or opted out of paying themselves a salary.
This indicates a crucial need for SMBs to effectively manage their cash flow, both for the survival of their businesses and the nation’s economy. Knowing how to manage and analyse cash flow is essential to generating long-term growth and overall business profitability.
What is Cash Flow?
Simply put, cash flow refers to the movement of money in and out of a business. It is essentially the net amount of cash your business generates and spends over a fixed period of time.
To generate a positive cash flow, a business’s inflow of cash needs to exceed its outflow. Alternatively, if outflow exceeds inflow, the cash flow becomes negative. Cash inflow is typically generated from sales as well as income from interest, investment, royalties, loans, and licensing agreements amongst many others. Key sources of cash outflow include operating expenses, debt repayments, capital expenditures, and dividend payments.
Most of the time, for investors and shareholders, a business’s ability to generate value is directly related to its ability to generate positive cash flows.
How does Cash Flow Work?
A business’s net cash flow (NCF) typically represents the total income generated from sales and received through investments. It subtracts the total sales from the cost of goods sold, depreciation, taxes, and other related expenses. It is often calculated using the formula below:
NCF = total cash inflow (TCI)- total cash outflow (TCO)
Alternatively, operating cash flow (OCF) represents a business’s ability to turn a profit without taking into account investments and interest. It solely considers the cash flow generated by operations and normal business activities such as the costs associated with service provision, payroll, marketing, and more.
While NCF provides a comprehensive look into a business’s overall profitability, calculating OCF analyses business profitability in terms of capital that is already owned. It indicates just how profitable a business is in generating an ongoing profit on a daily basis through everyday business activities.
To calculate OCF, the formula is:
OCF = net income + depreciation - change in working capital
It is important to keep in mind that cash flow differs from profit. While profitability indicates the amount of money left over in the business after all expenses have been paid, cash flow solely represents the flow of money in and out of the business.
It’s possible for a business to be profitable and have negative cash flow, impacting its ability to pay for expenses and invest in growth. Similarly, a business can have a positive cash flow but fail to make a profit. This is typically the case for many startups.
How to Analyse Cash Flow?
To conduct a cash flow analysis, a few simple steps have to be followed.
- First and foremost, start by gathering all necessary financial information about your business. Collect bank statements, receipts, income records, expense invoices and other financial documents that track the inflow and outflow of cash.
- Next, with the information, identify your net income for the period you’ve decided to analyse.
- Now, identify other sources of income and expenses during this period. To determine the exact amount of money certain business expenses are generating or depleting, take a look at your balance sheet at the beginning and end of each financial period.
- Now that you have all the relevant information needed, create a cash flow statement. Most cash flow statements incorporate three main sections – operating activities, investment activities, and financing activities.
Operating activities – This represents your business’s core activities.
Investing activities – This constitutes both internal investments such as equipment purchase and external investments in other companies in the form of stocks and bongs.
Financing activities – This refers to how your business is financed with both debt and equity from shareholder contributions.
- Start analysing your cash flow statement. The statement will reveal details about your expenditure and income such as the amount of cash to start with and ultimately, how much you ended up with.
How Can Mighty Partners Help?
Need to scale your business? At Mighty Partners, we provide solutions for SMBs to accelerate their growth within competitive markets.
We craft tailored alternative business funding solutions to accelerate your growth. Smooth your cash flow through our customisable debt financing options. Contact us today.
