Cash flow is a measurement of the amount of cash that comes into and out of a business in a given time frame. It’s critical to business operations, essentially determining the amount of money a business has available to pay suppliers, employees, and lenders or invest in growth.
Cash flow can be positive or negative. Positive cash flow means more money is coming into the business than leaving it. Negative cash flow means the opposite – that more money is leaving the business than entering.
Since cash flow influences working capital or the amount of money a business has to fund its day-to-day operations, businesses tend to aim to generate positive cash flow in most circumstances.
Sustained periods of negative cash flow prevent businesses from being able to cover their expenses, which can become an existential problem. In fact, cash flow problems are one of the most common reasons for business failures.
Types of cash flow
Cash flow is made up of three main components, which represent the major centers of both revenue and expense. They are:
Cash flows from operations (CFO): Operating cash flow is calculated by subtracting the costs of developing, producing, and distributing products or services from the revenue generated by selling them.
Cash flows from investing (CFI): Investing cash flow is calculated by subtracting the amount of money invested in company growth or assets from the revenue generated in the form of investment returns.
Cash flows from financing (CFF): Financing cash flow is calculated by subtracting the costs of financing arrangements (e.g. interest or dividends) from the amount of money generated through financing.
Generally speaking, businesses aim to generate most of their cash flow from operations, which is more sustainable over the long term. However, if businesses seek quick growth, it’s not uncommon for cash flows from financing to increase.
Why cash flow is important
Cash flow is of huge importance to all businesses, primarily because positive cash flow is required to meet day-to-day financial obligations like paying suppliers and employees.
Without sufficient cash flow, businesses are unable to pay their bills and, by extension, will face serious operational difficulties.
However, cash flow’s importance is also related to a business’s ability to pursue opportunities for growth. Generally speaking, growth-minded businesses will need to have excess cash to spend on more stock, additional equipment, or research and development.
So effective cash flow management isn’t just important for businesses hoping to survive, it’s also critical in terms of enabling them to thrive.
How cash flow is measured
To manage cash flow effectively, businesses need to be able to measure and analyze it. In the simplest terms, cash flow measurement is carried out using the following formula:
Cash flow = Total cash inflow – total cash outflow
However, most businesses will use more sophisticated measurement processes to get better, more meaningful cash flow data.
To begin with, cash flow measurement is usually limited to a specific time frame, like a financial year or quarter. It’s typically conducted in a cash flow statement, which allows finance teams to track all inflows and outflows in the relevant period.
This cash flow statement can also break cash flows into the three types mentioned above, providing greater visibility over where money enters and leaves the business.
Many businesses use dedicated cash flow software integrated with their enterprise resource planning (ERP) system to handle cash flow measurement. This software can provide more accurate analysis and also provides opportunities for automation, which reduces the amount of time spent measuring cash flow.
Forecasting future cash flow
As well as measuring cash flow in previous business periods, businesses also aim to predict future cash flow. Cash flow forecasting estimates the expected flow of cash coming into and out of a business in a given time period, from a month to years ahead.
This is an important consideration for businesses looking to maximize their cash flow management strategy.
Firstly, it provides valuable insights into what they can do to optimize cash flow in the near term. If a business forecasts cash flow for the month ahead and realizes there will be a surplus, for example, it can use that money to invest in growth.
It also illuminates potential cash flow risks, like projected periods of negative cash flow that could cause working capital issues. This is particularly important for businesses that are aiming to build resilience, which is critical in challenging business environments.
5 ways to manage cash flow
Businesses can see many benefits from improving their approach to cash flow management, creating resilience against risks, and opening up growth opportunities. These are some of the most common ways to increase cash flow management performance:
Optimize accounts receivable and accounts payable
Accounts receivable (AR) and accounts payable (AP) — representing money owed to a business by its customers and money a business owes to its suppliers — often make up a meaningful percentage of its total capital. Changes to how both accounts are managed can offer cash flow boosts.
On the AR side, businesses can use solutions like accounts receivable financing to collect payments more quickly without impacting their suppliers’ working capital positions. For AP, there are a range of solutions, including dynamic discounting and supply chain finance, that allow businesses to preserve their own working capital for longer.
Adopt a suitable inventory management strategy
Businesses often have a significant amount of cash tied up in raw materials or inventory, so inventory management can be used as a lever to increase cash flow. There are a range of different inventory management strategies to consider, each offering a different balance of inventory and working capital availability.
The key is to adopt an inventory management strategy that ensures the business can continue to meet all customer demand within target order fulfillment boundaries while minimizing any surplus inventory above this point to maximize working capital availability and cut inventory carrying costs.
Streamline operations for efficiency
Standard operations within a business all have associated costs, and increasing the efficiency of the processes can reduce that cost, which can in turn impact cash flow. There are lots of ways to approach streamlining operations, but integrating automation is a particularly popular option.
A variety of operations can be automated, either in part or in full, through dedicated tools like accounts payable automation platforms. These solutions don’t just improve efficiency, they can also result in fewer errors and increased accuracy.
Improve cash flow forecasting capabilities
Improving the accuracy of cash flow forecasting or adopting a more rigorous approach that involves creating forecasts on a regular basis can help businesses better identify upcoming opportunities or threats.
This means they’ll be better able to make optimal use of their working capital without exposing themselves to cash flow risks, which can help them decide whether to invest in growth or hold off on spending to build up a cash reserve.
Establish effective cash flow KPIs
Cash flow key performance indicators (KPIs) help businesses measure and analyze their cash flow situation more effectively. Adopting a sophisticated approach to cash flow measurement and committing to carrying out analysis against pre-set KPIs regularly allows businesses to track improvements and adjust strategies accordingly.
Deciding which KPIs to focus on depends on the business’s specific cash flow objectives, such as funding growth, limiting debt, or increasing resilience to external factors.
FAQs
Flexible Funding 2.0 is designed to help you meet your short-term cash objectives. Use Flexible Funding when you need to:rnrn • Make DPO or CCE improvements for financial reportingrn • Free up cash for an unplanned initiative (not forecasted)rn • Avoid running short on cash payment accounts (due to early payment demand)rn • Leverage a low-risk investment option for idle cashrn • Maneuver as market conditions shiftrn • Improve supplier relationships with access to reliable cash flowrnrnrn
Generally speaking, no. Flexible Funding offers a blended experience of Taulia’s Supply Chain Finance and Dynamic Discounting solutions. Whereas Supply Chain Finance permits one early payment offer per day, Dynamic Discounting presents multiple offers on a sliding scale the user can review on a digital calendar. Selecting fixed or variable-rate financing with Dynamic Discounting will influence whether suppliers receive one or multiple offers per day in certain situations when Flexible Funding is activated. Consistent pricing between funding sources — structured in advance through collaboration by all parties — also ensures a unified experience for suppliers.rnrnrn
Rate parity concerns the consistent cost of supplier financing between funding sources. Traditionally, companies have sought to maximize their yield on dynamic discounting while insisting banks keep their margins thin on accelerated payments for suppliers. This rate disparity incentivizes suppliers to “shop” for the best price when both funding sources co-exist in a Flexible Funding-enabled program. A better approach is fair and consistent pricing between funding sources so that suppliers feel like they get a good deal on needed liquidity and buyers optimize the return on their investment with high supplier participation.rnrnrn
Cash flow measures money entering and leaving a business. Learn everything you need to know about this important metric in our glossary post.
Read our full guide to sustainability in supply chain management, covering what a sustainable supply chain actually means and how it can benefit a business.
Accounts receivable automation (or AR automation) is the practice of automating parts of the accounts receivable process in a business. Learn more here.
Flexible Funding is a feature for Taulia Payables that allows buyer organizations to use the right funding at the right time. It gives corporate treasurers options to meet their short-term cash flow needs without restricting the liquidity suppliers rely on.
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Working capital funding, also known as working capital financing, is a method of business financing. Learn more about the types of working capital funding here.
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