Business Basics: Cash Flow

cash flow

Money Flowing In & Out. Sales are vanity, Profit is sanity, Cash is reality. The biggest cause of business failure is lack of cash. Without sufficient cash flow, a company simply cannot function. "Cash flow" is the term used for money that comes in and out of a business.

"Inventory management can be hard for any business to do well.Whether you're in manufacturing or retail, your business can suffer if you have too little stock – or too much." - Xero.

Too much inventory sucks up cash, too little stock means it is more difficult to satisfy customer demand, and can limit a business’s ability to grow.

Positive & Negative Cash Flow

If a business is seeing more money coming in rather than going out of the business this is known as positive cash flow. If there is more money going out of the business than coming in, this is known as negative cash flow.

It's important to note that just because a business may be experiencing negative cash flow for a duration doesn't necessarily mean that that company is going to suffer a loss. This is because cash flow is dynamic. It is also true in the reverse scenario whereby positive cash flow doesn’t necessarily equate to making a profit.

A Cash Flow Statement reports on a where a business’s money is coming from and going to.

What is Cash Flow?

Cash flows in to a business from a number of sources:

  • Collecting cash from sales of products and services
  • Funds introduced by the business owners
  • Loans from external sources

Conversely cash flows out of the business in several ways:

  • Purchasing goods and services to operate the business
  • Paying wages
  • Repaying loans and interest
  • Drawings taken by the business owners
  • Paying taxes

Calculating Cash Flow

Accountants calculate cash flow in a number of ways for different purposes, but the simplest is to monitor your month end bank balances over a period of time.

The graphs below are two different ways of viewing how your cash is tracking over time.

It is all about the trends – downhill trends should cause alarm bells!

cashflow diagram engine room charatered accountants

How to Fix Cash Flow Problems

By regularly updating your records you can keep track of the flow of money that comes in and out of your business. Keeping track of your cash flow allows you to plan for periods of low cash flow (such as seasonal downturns etc.) and identify the right times to buy certain assets.

Growing businesses always require more cash as they invest in more stock, staff and equipment so pre-empting issues through good planning is key.

If your business is showing a deteriorating cash position, there are some important places to look first:

  • Are stock levels increasing? Increasing stock levels consume cash because you often have to pay for it before it is sold.
  • Are accounts receivable increasing? This may be because your business is growing, or it may because you aren’t keeping an eye on who has and hasn’t paid.
  • Are you struggling to pay the Inland Revenue Department?

What you can do to help:

  • Reduce slow moving, old or seasonal stock
  • Chase overdue accounts receivable – don’t be a loan facility for your customers
  • Tighten credit terms – make habitual bad payers pay COD.
  • Talk to the IRD about paying off your overdue debt
  • Free up cash by selling unused plant and equipment.

Engine Room Are Your Financial Experts

Engine Room was established in 2001 to support small-medium sized New Zealand businesses and they take pride in providing high-quality Business Coaching, Financial Management and Accounting Services in a professional, down-to-earth manner.

If you are struggling with your company's financials, your numbers aren’t adding up or if you're just looking to lessen the load, contact the financial experts at Engine Room Chartered Accountants.

Contact our Auckland office on 09 238 5939, Tauranga on 07 579 5011 or free phone 0800 236 446 for a no obligation chat.

If you prefer, you can email us by heading to our contact page.


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