There is an old saying about running a business: Cash is King.
And if so, then the Cash flow is the blood that keeps the heart of this king’s kingdom pumping.
Cash flow is one of the most important components of small or medium-sized business success.
Without cash, profits mean nothing.
It just stays in the books and does not help smooth operations.
Many businesses end up bankrupt because the value of the revenue does not match the amount of cash.
Thus, managing cash flows is crucial for business success.
So, let us try to understand cash flows and how to manage them.
The term cash flow
means the total amount of cash and cash equivalents transferred within and outside a business.
Receipts of earned income imply cash inflow, and paid expenses indicate cash outflow.
The company’s ability to generate value for the shareholders is primarily determined by its ability to generate positive cash flow or, in particular, increase long-term free cash flow (FCF).
Simply put, Cash flow is the amount of cash a business receives and pays.
Businesses spend money on expenses and earn money from sales as revenue.
They may also earn income from interest, investments, payments, and licence agreements and sell products on credit, expecting to receive the amount they owe at the end of the date.
Assessing time, uncertainty, and amount of cash flows, as well as where they will go and come from, is one of the most important objectives of financial reporting.
Assessing the company’s financial viability, flexibility, and overall financial performance is highly crucial.
Positive cash flows indicate that the company’s liquid assets are growing.
This growth enables the company to repay its obligations, reinvest in its business, return money to shareholders, pay costs, and protect against future financial challenges.
Companies with solid liquidity can live better during financial crises, avoiding the costs of financial stress.
Cash flows can be analysed using the cash flow statement, the general financial statements that report company resources and expenditure over a specified period.
Company executives, analysts, and investors can use it to determine how a company can obtain cash to pay off its debts and control its operating costs.
The cash flow statement is one of the most critical financial statements issued by the company, as well as the balance sheet and income statement.
The different types of cash flow are categorised based on the nature of activities responsible for the flow. The various types of cash flow are as follows:
Cash flow from operating activities refers to the cash flows involved in the production and sale of goods from normal operations of the business.
The positive cash flow or cash flow income from operating activities indicates that the company has sufficient operating income to pay off its operating expenses.
In other words, there should be more operating cash flow than operating cash outflows for the company to be financially viable in the long run.
Net operating cash flows are calculated by subtracting the operational expenses paid in cash from the operating incomes received in cash.
Net operating cash flows are recorded in the company’s cash flow statement. Net operating cash flows also indicate whether a company has the potential to expand its operations.
Note that the operating cash flow helps classify cash received from customers and sales.
If, for example, a company produces large sales from a customer, it will increase revenue and profits.
However, additional income does not improve cash flow when there is difficulty in collecting payments to the customer.
For example, if a company made a sale of Rs. 50 Crores to a customer but received only Rs. 20 Crore.
The company’s sales increase the company’s revenue by Rs. 50 Crore.
At the same time, the operating cash flow will increase by Rs. 20 crores only.
This indicates that the company was not able to acquire cash from the customers in an effective way.
Cash flow from investing activities indicates the amount of money generated or spent on various investment-related activities over a specified period.
Investment activities include the purchase of shares, securities investments, or the sale of securities or assets.
Poor cash flow revenue from investment activities may be due to a large amount of cash invested by the company in long-term assets of the company, such as research and development (R&D), which is not always a warning sign.
Cash flow from financing activities indicates the total cash inflow used to fund a company and its capital.
Financial transactions include transactions involving debt generation or repayments, equity, and interest payments.
One can understand the company’s financial capabilities and how well the execution of corporate capital structure finances and its management by analysing the Cash flows from financing activities.
Cash flow analysis determines a company’s income available in cash to pay off its expenses.
That is calculated as current assets (cash or cash equivalents, as receivables) minus current liabilities (liabilities payable during the coming accounting period).
This calculation determines the working capital of the company.
It states whether your business can pay off its debts and generate enough cash to continue operating for an extended period can be understood using cash flow analysis.
Long-term positive cash flow is often a sign that good things are about to come, while negative cash flow conditions can indicate potential downfall.
Cash flow is an essential factor that determines the company’s liquidity, financial position, and flexibility in its operations.
The company might have negative impacts in the long run due to weak cash flows. The following are some reasons for weak cash flows and their consequences:
Advertising or taking an order of high volume may result in overspending by the company.
Further, the absence of receipt of cash from customers with huge orders will add up to the company’s liquidity burden until the amount is received.
The company may stock up the inventory to fulfil the high market demands.
A sudden change in such demand can block a substantial amount of cash in such unsold inventory.
This situation, in turn, creates operational challenges for the company.
Companies may allow customers a more extended credit period for payment to promote sales and attract customers.
That keeps cash invested in raw materials for an extended period, creating stress on working capital.
Thus, keeping an optimal payment cycle keeps the working capital flows.
The different ways to improve cash flow are as follows:
To speed up the receipt, the company should make a good credit and cash management system. Companies should have bank accounts in banks that have branches, even in rural areas.
These customers in rural areas can send payments, and their cheques will be processed by banks as soon as possible. The company should ask customers to approve cheques in advance.
The company can also try to give discounts to customers if they pay their bills immediately.
Businesses often have to give extended credit to customers to attract them, especially when they are just starting or growing.
But businesses should research in advance to find the risk of extending the credit period to the customers.
Can they pay their bills on time?
Is their business growing or weakening?
Are they having income problems?
One should be well aware of the indicators.
The company should take the initiative to tighten credit-providing norms. As a result, customers with good credit ratings will only be eligible for credits, reducing the risk of nonreceipts of payments and improving the cash flow.
Another option to increase the cash flow is to give customers discounts if they pay in advance.
While the company’s profit margin may be affected by this practice, it can help the company manage cash flow by encouraging customers to make payments ahead of payment cycles.
If a company needs more money, it should try to attract new customers or sell additional goods or services to its existing customers. But this may be easier said than done.
Acquiring new customers is essential for a growing business, but turning prospects into sales can take time and money.
It may also need high sales and marketing expenses.
Selling to existing customers is cheaper, and you can do this by analysing what they buy and why – information.
It could lead to an increase in your profit margin and, hopefully, generate more revenue.
But businesses need to understand that increasing sales may simply increase the revenue in the books of accounts and not actual cash if this sale is not a cash sale.
Thus, the company needs to increase cash sales to increase cash flows.
A cash flow statement is part of the financial statements of the company summarising cash flows and cash equivalents (CCEs) coming in the company and going out of the company.
How good a company is in managing its cash position is indicated by the cash flow statement, which means how well a company generates cash to pay off its debt obligations and finance its operating costs.
The Cash flow statement is one of the three most important financial reporting statements.
Thus, it complements the Statement of profit and loss and the Balance sheet.
Revenue refers to the revenue generated by the sale of goods and services. If the item is sold on credit or through a paid payment system, the money may not be received from that sale and booked as receivable accounts.
But, these do not represent the real income of a company at that time. Revenue also tracks outflows and inputs and separates them according to source or usage.
For example, if a company had credit sales of Rs. 500 in the previous year and credit sales of Rs. 600 in the current year. The company received Rs. 100 of the prior year’s accounts receivables and received Rs. 450 from the current year’s credit sales.
Then,The company’s revenue for the previous year was Rs. 500, while the Cash flow was only Rs. 400 as Rs. 100 was still outstanding at the end of the year. And the current year’s revenue is Rs. 600.
The current year’s cash flow will be Rs. 550 (Rs. 100 from the previous year’s sale + Rs. 450 from the current year’s sales).
Cash flow management is the process of tracking how much cash is coming into the business and how much cash is going out of the business.
Cash flow management helps predict how much access to cash will be there for the business in the future. It also allows you to determine how much your business needs to pay off debts, such as paying employees and suppliers.
Cash flow is a term used to describe changes in the amount of cash a business has from one period to another. Such changes are analysed and traced by cash flow management.
This type of management helps you identify trends, plan for the future, and deal with any problems with your cash flow.
Conclusion
In a nutshell, we understood that cash is the blood and fuel to run any business and meet its operating expenses.
Cash flow management becomes crucial during times like the pandemic we are recently facing.
A company with an excellent financial structure and cash position is always ready for such times.
Not only the companies or business units, but you may also use cash flow and cash flow management techniques in your daily life.
Individuals can use cash flow management to manage their income, living expenses, and money management.
Cash flow does not reflect all expenses of the company, and that is because the company does not pay all its costs immediately.
Although a company may have liabilities for outstanding expenses, any payments attributed to these liabilities are not recorded as cash outflows until the cash transaction occurs.
Free cash flow is the money left over after the company has paid its operating costs with Capital expenditures.
It is the money left over after paying the routine expenses like payroll, rent, and taxes. Companies are free to use FCF at their discretion.
Knowing how FCF is calculated and analysed helps the company with its financial management.
It will give investors an understanding of the company's finances, which will help them make better investment decisions.
Cash and cash equivalents are combined in one line on a company's balance sheet.
It reports the number of business assets that are currently in cash or that can be converted in a short period.
Cash and cash equivalents include cash, bank accounts, and other very liquid, short-term investments.
Examples of cash equivalents include transaction paper, negotiable instruments, etc.
Cash flow analysis usually starts with the cash flow statement, which classifies the cash flow of the company of operations, financing, and investment.
The analysis includes looking at trends, solid performance areas, cash flow problems, and opportunities for improvement.
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