They say money makes the world go round, but when was the last time you evaluated your company’s cash flow?
Whether you’re struggling to pay employees or looking to inject funds into a new project, it can be challenging to get your hands on cash when you need it most.
With 60% of SMEs failing due to poor cash flow, knowing how to monitor your income and expenses is essential to success.
Join us as we explore four different types of cash flow you need to know and offer top tips on solving cash flow problems in small businesses.
Why Is Cash Flow Important to a Small Business?
Before we get into the nitty-gritty, let’s make sure we’re all on the same page and understand what we mean when we talk about cash flow.
Put simply, cash flow is the amount of money coming in and out of your business at any given time.
Weirdly, we like to compare cash flow to filling up a bathtub:
- When you turn the tap on, water comes in.
- When you turn the tap off and remove the plug, water drains out.
To maintain healthy or positive cash flow, the key is to keep the bath topped up with a healthy balance of water coming in (i.e., revenue) and water draining out (i.e., costs). You can then help your business grow by injecting excess funds into new projects and investments.
Importantly, positive cash flow does not necessarily equal profit. A high positive cash flow may indicate your business isn’t holding enough stock and you could be losing sales due to shortages.
So, why is getting cash flow right so important?
Well, the tricky thing for most businesses is regulating the flow of money coming in and out of their business. The water tap won’t always be on full blast and the plughole won’t always be shut tight.
Whether it’s waiting for incoming invoices or paying employees at the end of the month, cash flow can fluctuate.
But, carefully managing your cash flow helps avoid periodic changes and maintain a steady stream of money throughout the year. So you can continue to grow and scale your business.
1. Cash from Operating Activities
Cash from operating activities is the money generated by your core business activities. For most organisations, this involves selling products or charging customers for services.
It’s essential to create a benchmark of the current financial success of your core business activities.
Cash from operating activities does NOT include income generated from either of the following:
1. Investments (e.g., selling property and dividend payments from long-term investments)
2. Financial activities (e.g., issuing shares and borrowing from lenders)
Typically, you can determine cash from operating activities by converting your net income, adding depreciation expenses, and adjusting for the following changes:
- Accounts payable
- Almost any other current assets
Note: The net income is based on the reported revenues on a company’s income statement at the time of earning — even if the customer pays 30 days later.
2. Free Cash Flow to Equity (FCFE)
Free Cash Flow to Equity or FCFE is the money available after you’ve reinvested into your company. Businesses use this method to measure the amount of money available to equity shareholders after expenses, debt repayments, and reinvestments.
You can calculate FCFE using a simple formula:
FCFE = [Cash from Operations] – [Capital Expenditures] + [Net Debt Issued]
Business owners often use FCFE to determine the value of their company.
While many financial analysts prefer the traditional dividend discount model (DDM) to determine business valuations, FCFE is becoming a popular way to value companies that don’t pay dividends.
FCFE can be particularly useful for identifying whether any form of financing was used to cover the costs of share repurchasing.
If the FCFE is less than the share repurchases, this often suggests that the company is relying on either retained earnings or borrowed cash — a red flag for investors.
Finally, if the cash spent to pay dividends or repurchase stocks is roughly equal to the FCFE, this often means that the business is paying out all of its shares to investors.
3. Free Cash Flow to the Firm (FCFF)
Free Cash Flow to the Firm or FCFF is the theoretical cash flow your company receives, assuming you don’t have any debts.
You can use FCFF to measure the health of your business and represent the amount of cash flow after taking account of the following:
- Depreciation expenses
- Working capital
In essence, FCFF is a useful way to determine your profitability after expenses and reinvestments. For many business owners, FCFF is the most important financial indicator to determine the real value of their firm.
How Do I Interpret FCFF Values?
- A positive FCFF value indicates your business has excess cash after expenses.
- A negative FCFF value suggests you haven’t made enough money to cover your overheads and investments.
Importantly, a negative FCFF value does NOT always indicate a poor investment opportunity. Many emerging tech companies (e.g., Uber, Tesla, and Spotify) don’t need to turn a profit to attract huge investment and continue to grow in value.
If a business has a low FCFF value, you need to investigate the underlying circumstances and whether it’s an indication of poor operational performance or a rapid surge of investment.
4. Net Change in Cash
The net change in cash is the overall difference in cash flow from one accounting period to the next.
Monitoring your business’ net change in cash is a good way to make sure you don’t run out of money. You can calculate this figure by looking at your company’s cash flow statement.
To attract outside investment, business owners ideally want their cash balance to increase at the start of each period to indicate healthy growth.
However, as we already explained with the FCFF value, a drop in cash balance doesn’t necessarily indicate poor financial health. Whether it’s investing in a side project or donating lump sums to charitable causes, you might experience temporary blips in cash flow for a variety of perfectly good reasons.
How to Improve Cash Flow
If we imagine the periodic changes in cash flow as a zigzag on a graph, cash flow management aims to avoid constant ups and downs and smooth the line into a gentle upward curve.
Maintaining healthy cash flow isn’t an easy task, but you can:
- Cut costs. There will always be areas of your business where costs can be cut. Whether it’s capping expenses or cutting the budget for your Christmas party, you can always find corners to cut.
- Delay payments to suppliers. Disappointing your suppliers should never be your first port of call. However, if cash flow is really tight, some businesses use delayed payments as a last-ditch attempt to reduce cash outflows.
- Reduce or delay expansion plans. Whether you’re planning a new venture, looking to open a new office, or planning to take on new employees, expansion plans can be a significant drain on cash flow. Delaying these plans or simplifying them can be a useful way to reduce outgoings.
- Reduce credit periods. If your business offers customers credit when they pay for a product or service, there will often be a delay in incoming cash. Reducing this credit period is a helpful way to increase cash flow. Prompt-payment discounts can also be a useful way to encourage customers to pay as soon as possible.
- Reduce the amount of stock you hold. Ordering less stock from suppliers and encouraging quick buys on excess inventory helps to release cash when you need it most.
Single Invoice Financing
Single invoice financing makes it easier than ever to control cash flow and avoid periodic ups and downs.
Financing is an asset-based financing solution that can give your business access to liquid capital when cash flow is tight as you receive an advance payment on unpaid invoices.
Traditionally, financing firms lock businesses into long-term contracts and will only offer advance payments if they continually submit receivables. However, with single invoice financing, your business can enjoy the freedom and flexibility of instant one-off advances of payments with zero commitment.
Single invoice financing allows your business to receive advance payments on specific accounts and gives you the power to decide if and when you use invoice financing to boost cash flow.
Increasing Cash Flow in Small Businesses Has Never Been Easier with Lendflo
Here at Lendflo, we’ve made it our mission to take the pain out of cash flow management with a clear and straightforward approach.
Enjoy instant approvals and receive funds in seconds with Lendflo. Our smart digital platform integrates with leading accounting software for a stress-free application process that eradicates paperwork and headaches.
Lendflo unlocks the power of machine learning to understand your business’ individual needs and offer better rates on individual invoice financing. So, you can access instant cash for outstanding invoices before customers have even paid them.
Helping you to get your hands on the money you need to inject vital funds and grow your business to new heights.
Check out Lendflo today.