What exactly is cash flow?

The traditionally accounting trading record is the Profit and Loss statement which records all invoiced sales and all expenditure invoices. So once all sales are received and all expenditure paid for, the total sales less total expenditure if of course the total profit or loss. However the timings of sales and expenditure are often extremely important. Sales income is only finally achieved when the money is in your account, and expenditure is actually made when the money leaves your account. These timings are often referred to as Cash Flow.

Why Cash Flow is so important

Cash flow management is so important because when you need to know how much money your business actually has at any given time. Even if your business is profitable, the income and expenditure timings can have a dramatic effect on your bank account. So if you've made sales of £1,000 and you intend to spend £600 to buy more stocks to prepare for the next batch of sales, you want to receive this £1,000, or at least £600 of it, before making your next expenditure. Otherwise you go into debt or borrow it or draw from your reserves.

Suppose you do borrow it because you believe your sales are bound to succeed, and you do indeed make another £1,000 of sales out of this stock. However suppose the first sales batch of £1,000 is still outstanding (the customer has said the cheque is in the post) and the second batch is also outstanding as you've only just made the sales. Now you want to buy more stock for your successful business to fund the next batch of sales. What do you do? This is the kind of situation which, if not anticipated, can kill your business, because you can run out of cash as you try to fuel your expansion. So what can you do about this? One way would be to prepare a Cash Flow Forecast.

Cash flow forecasting

Cash flow forecasting is a technique which estimates the actual sales received dates into your account and the actual expenditure payments dates out of your account over a number of periods, such as twelve months. Then for each period you would subtract total outflows from total inflows to calculate the net cash flow. You would then calculate your cumulative cash flow across all the periods. We'll next look at factors affecting incoming cash timings, outgoing cash timings, and then describe how to determine cumulative cash flow.

You could estimate the timings of sales, and in particular the delay between a sales invoice being raised and the money arriving into your account from your own experience or by making an educated guess. In some businesses sales might be cash based and therefore income might be deposited into your account daily or weekly. In other businesses you might receive payments from your customers a certain number of weeks after sending them your invoice. Unfortunately the delay in sales payments is often longer the bigger the customer is.

You could estimate the timings of your expenditure items similarly. Perhaps you pay some bills immediately, within seven days or after thirty days, so you could add these to your forecast accordingly. Other expenditure items, such as for heating and lighting and rates are due at set dates through the year, so these can also be included in your forecast on these due dates. Then for each period you calculate your net cash flow as total inflows minus total outflows.

You can then calculate then cumulate cash flow. This will show how much money you actually plan to have at the end of each period through the twelve months. To do this you need to add two lines of analysis under the net cash flow calculation for each period. These are "Period Start" and "Period End".

For the first period you might be starting from scratch, so the "Period Start" amount would be zero. The "Period End" amount for period one is "Period Start" plus net cash flow. For period two, the "Period Start" amount is taken from "Period End", period one. The "Period End" amount for period two is again "Period Start" plus net cash flow.

So in essence you carry forward the "Period End" amount for each period into the "Period Start" amount in the next period. The "Period End" amount is the cumulative cash flow at the end of each period. In this way you forecast the fluctuating amount of your bank balance across all the periods. This information helps you anticipate peaks and troughs well in advance, and you can manage these by, for example, delaying certain expenditures, or by pushing certain sales, or asking your bank for an overdraft to get you through a particularly deep trough.

Planned versus actual

It's also very useful to record your actual income and expenditure details against your plan, to help you understand the business processes and to help you build a more accurate cash flow forecast next time around.

Understanding Cash Flow in your business is about knowing the timings of all your incoming and outgoing money and this information often comes from your knowledge of your own particular business. Even if your business is successful you may well have cash peaks and troughs, and these can be managed by effective Cash Flow forecasting. One way to find out much more about Cash Flow management and or other business topics would be to attend a training course and take your business skills to the next level.