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Understanding Cashflows in Business – A Guide to Business Liquidity and Growth

17/04/2018
Reading Time: 3 mins read
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There is the popular saying in business that “cash is king” and if that is anything to go by, then cashflow will be considered as the oil that keeps the vehicle engine (i.e. business) running. To grow and sustain business, cashflow is one of the integral tool which cannot be underscored because without cash profit is basically meaningless as many profitable businesses have ended up in bankruptcy because the cash inflows does not compare with cash outflows. Firms that don’t exercise good cashflow management may not be able to make the investments needed to compete, or they may have to pay more to borrow money to function.

Cashflow is categorised as below:

Operating Cash Flows – cash flows related to sales (income) and business expenditures i.e. operating activities that 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.

Investing Cashflows – generation of cash flows from activities that relates to the purchase and sales of fixed assets (for instance, property, plant or equipment).

Financing Cashflows – generate cash flows through the investment of money into the business by the owners or lenders. Bank loans, Credit as well as principal repayment of such loans are classified as financing cash flows, however, interest payment of loans is classified as an operating activity. Increase or decrease in owners’ capital in business creates changes in equity and these movements are also associated with financing activities.

Signs of Poor Cashflow Management

  • decreased liquidity – running out of working capital
  • overtrading – turning inventories faster than trade averages
  • excessive short – term debt
  • missing discounts – payables over terms
  • slow collections – outstanding receivables piling up

Effects of Poor Cashflow Management

  • Missed opportunities – causing a business to miss great business and investment opportunities
  • Diminished competitive advantage – eroding the competitive advantage of a business due to inadequate finances to achieve competitive edge over its competitors.
  • Restricted Growth – Business growth prospects will all go down the drain due to inadequate cashflow
  • Threatened existence – Negative cash flow threatens the very existence of business as the business could become insolvent
  • Poor relationships with suppliers – Increasing default in payment to suppliers may cause tension in your relationship with them or end the relationship altogether.
  • Increased interest and bank charges – The need to secure external funding could come with extra cost which will affect your profit and cash flow.

From the same author: Fraud Detection and Prevention in Financial Reporting – Is it the Auditors’ Responsibility?

How to Manage Cashflow to Ensure Business Liquidity and Growth

• Balance the trade-off between payables and receivables – i.e. balance the collection of receivables and the payment of suppliers particularly in setting up credit terms.
• Tightening credit requirements – credits must be based on customers risk profiling and capability, with” wholesale” credit discouraged.
• Increasing sales – If you need more cash, then it obviously suggests you need to attract new customers or sell more to your existing customers.

• Pricing discounts – To reduce increasing account receivables and increase cash flow, one option to consider is to offer trade discounts for prompt payments.
• Securing loans – Business may also opt for short terms to manage short-term cash flow problems if the situation so allows for such.                                                                      • Cash flow tracking or monitoring – Periodic tracking and monitoring of cash flow is helps to determine if the business is creating the type of cash flow to grow and helps to develop reliable cash flow forecasts.

Conclusion
If you ever think growth is the antidote for cash flow problems, then you must revise your notes because businesses that held the same assumption later realized that their increasing goal of growing business without reference to cashflow resulted in the worsening of their cashflow problems. As you plan for growth, do same for related cashflows to avoid surprises.

A must read: Equity Financing: The Accountants’ Perspective

Desmond Aidoo

About the Author – Desmond Aidoo

A Financial, Audit and Tax Consultant at Danisa Consult (Accounting, Audit & Tax) and a Facilitator for Accounting, Tax and Audit at Global Institute of Resource Development (GiRD), a Capacity Development and Training Institution.

 

Comments and suggestions to dajdesmond1@gmail.com /0242844114

 

 

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