Study Notes: Business Finance & Accounting

Introduction to cash flow management

In an ideal world, a business will experience a consistently positive cash flow – i.e. the amount of cash coming into the business (cash inflow) is greater than the cash going out of the business (cash outflows)

This would allow a busness to build up cash reserves with which to plug cashflow gaps, seek expansion and reassure lenders and investors about the health of the business.

However, it is important to note that income and expenditure cashflows rarely occur together, with inflows often lagging behind.

An important aim of effective financial management must be to speed up the inflows and slow down the outflows.

Cash inflows

The main cash inflows are:

• payment for goods or services from customers
• receipt of a bank loan
• interest on savings and investments
• shareholder investments
• increased bank overdrafts or loans

Cash outflows

The main cash outflows are:

• purchase of stock, raw materials or tools
• wages, rents and daily operating expenses
• purchase of fixed assets - PCs, machinery, office furniture, etc
• loan repayments
• dividend payments
• income tax, corporation tax, VAT and other taxes
• reduced overdraft facilities

Many of the regular cash outflows, such as salaries, loan repayments and tax, have to be made on fixed dates. A business must always be in a position to meet these payments, to avoid large fines or a disgruntled workforce.

To improve everyday cashflow a business can:

• ask customers to pay sooner
• chase debts promptly and firmly
• use factoring
• ask for extended credit terms with suppliers
• order less stock but more often
• lease rather than buy equipment
• improve profitability

Cashflow can also be improved by increasing borrowing (lending), or by putting more money into the business. This is acceptable for coping with short-term downturns or to fund growth in line with the business plan, but shouldn't form the basis of day-to-day cash flow management.