Importance of cash flow management in business

Success or failure in business depends on how a business manages its cash resources. Cash in the business sense is not just notes and coins, but should be understood to mean cash flow. Without positive cash-flow, a business will not survive for very long. Why is cash flow so vital to the success of businesses, large and small?

BY CLIVE MPHAMBELA

The answer lies in that every business needs cash ( in the cash flow sense) to operate and grow. Cash ensures that the business is able to purchase supplies, pay for its rentals, advertising costs, hire employees or take care of the myriad other business activities that require money?

In short, cash flow is the lifeblood of any business, and it is imperative that, as a business minder, you get to understand the ins and outs of cash flow management.

In this week’s article, we will take a closer look at just how cash flow works and why it is an important aspect of sound business management.

The first step in understanding what cash flow really means in your business is first to appreciate the main sources of cash for any business, as well as the many uses of cash in the day-to-day running of a business and how they relate to the eventual health of the business.

What are the sources of cash inflow?

Generally cash is generated into a business through;

*Sales of the company’s products or services, also called revenues.

*Loans or proceeds from any forms of credit or borrowings made by the business

*Disposal of assets

*Contributions by the owners in the form of capital or shareholder loans

Cash flows out of a business mainly through;

*Day-to-day business expenditures, such as rent, wages and salaries, purchase of inputs (raw materials), payments for services such as telephones, advertising etc.

*Repayments of loans (principal and interest payments)

*Purchases of business assets

*Withdrawals by the owners through dividends

These cash inflows and outflows can be categorised into three main business activities.

Operating cash flows,which are essentially cash flows related to sales (income) and business expenditures
Investing cash flows, which cover fixed asset sales and purchases

Financing cash flows, which relate to loan payments and proceeds from new loans, and owner contributions (shareholders funds) and withdrawals by owners.

Why are operating cash flows the most important?

Ideally, a sound business should be generating the majority of its cash flow from operating activities, that is, the sale of real products or services. This is critical for the long-term success of the business as the other two aspects, investing and financing cash flows — are not always viable ways to manage and grow your business in the long term. A business that continuously resorts to borrowing from lenders or getting funds from shareholders to stay afloat is not fundamentally a sound business. It is just a cash sink, literally!

Operating activities generate cash inflows and outflows through the sale of your company’s products and services and the purchase of raw material supplies and other general day-to-day business expenditures. The operating cash flow reflects a summary of daily activities of your business and ultimately its health.

There will be times that additional cash inflows and outflows are generated by the business through investing or financing activities, but these are supplementary aspects and should not be the core source of cash for your business.

Cash flows from investing and financing activities

The generation of cash flow from investing activities relates to the purchase and sales of fixed assets (for instance, property, plant or equipment). Financing activities generate cash inflows through the investment of money into the business by the owners or lenders. Proceeds of bank loans and credit givers as well as principal repayment of such loans are classified as financing cash flows. However, the payment of the interest on these loans and credits is classified as an operating activity.

When the business owners invest or withdraw money from the business, it creates changes in the equity of the business and these movements are also associated with financing activities.

Why does cash flow represent the health or otherwise of a business?

It is important to understand how the inflows and outflows of cash in your business reflect the health of your company. A business must generate positive net cash flow. That is the difference between cash coming in and cash being paid out during any time period should as a general rule be positive. Cash inflows must be greater than cash outgo. There are times when your business may require to cover gaps created by the operating cash flows by selling assets or borrowing (cash flow from investing and financing activities.) However, the long-term success of your business, requires that it must be generating high sales and, therefore, creating positive cash flow from operating activities.

How can you create a basic cash flow statement?

It is not rocket science — you can easily create a cash flow statement by simply taking into account all your business’ inflows during a defined time period and subtracting the cash outflows to obtain the net change in your cash position for any given time period, usually on a monthly basis. This can be done manually, and if you do not want to do it manually, one of the simplest ways to generate financial statements is to use an accounting software package or a spreadsheet tool, which are all very easy to use.

Why are financial records important?

From historical cash flow records, one can easily do cash flow projections, which should become part of your budgeting process to ensure and demonstrate that you are being proactive in managing your business. Bankers, particularly become concerned if a business owner does not understand the basics of cash flow for their business.
You do not have to be an accounting expert, but understanding how your business generates and uses cash means that you will not find yourself in a cash flow crunch or cash bind, where you are waiting for payments from clients, but your business is still expected to pay its operating bills.

What is the importance of a bank account in cash flow management?

Opening and maintaining a bank account and developing a discipline of banking all cash proceeds and making all your payments from the bank account helps you create a credible record.

The bank statement is essentially a basic cash flow statement and when your business is doing well your bank balance will increase over time. If your bank balance is falling rapidly it means your cash management skills or your business model needs a relook. Going through your bank statement will tell you how, when and how much you spent on what. It also reveals where your money is coming from.

It makes things really very simple. Understanding where your cash is coming from and going to is a critical part of smart business management.

Clive Mphambela is a banker. He writes in his capacity as advocacy officer for the Bankers’ Association of Zimbabwe. BAZ expressly invites players in the MSME sector and all other stakeholders to give their valuable comments and feedback related to this article to him on [email protected] or on numbers 04-744686, 0772206913