Understanding Your Cash Flow: What Your Numbers Are Really Telling You

Cash flow is one of the most important things a director needs to understand.

You can have a profitable business, a healthy order book and plenty of work coming in, but still find yourself struggling to pay the bills.

That is because profit and cash are not the same thing.

Your profit and loss account tells you whether the business is making a profit.

Your cash flow tells you whether there is enough money available to pay what the business needs to pay, when those payments are due.

For directors, understanding the difference is important.

It can help you identify problems earlier, plan for upcoming payments and make better decisions about spending, borrowing and growth.

In this guide, we'll explain what cash flow is, how to read a cash flow forecast, which numbers you should pay attention to, how far ahead you should forecast and what you can do if the figures start showing signs of pressure.

What is cash flow?

Put simply, cash flow is the money coming into and going out of your business.

Cash comes into a business through things such as:

• Customers paying invoices
• Card or online payments
• Loans and finance
• Investment
• Asset sales
• Other business income

Cash goes out through things such as:

• Wages
• Suppliers
• Rent
• Utilities
• HMRC payments
• Loan repayments
• Finance agreements
• Insurance
• Stock
• Equipment
• Other business expenses

Your cash position changes depending on the difference between the money coming in and the money going out.

If more cash is coming in than going out, your available cash generally increases.

If more is going out than coming in, your available cash decreases.

The important point is that timing matters.

A customer might owe you £20,000, but if they are not paying that invoice for another 60 days, you cannot use that £20,000 to pay today's bills.

This is one of the reasons a business can appear profitable but still run into cash flow problems.

Why does cash flow matter so much?

A business needs cash to pay its bills when they become due.

You may have sales coming in, but if customers are taking longer to pay, your cash position can become tighter.

You may also have a particularly expensive month coming up because of VAT, PAYE, Corporation Tax, rent, insurance or annual payments.

If you don't know these payments are coming, they can create a sudden cash flow problem.

Cash flow forecasting gives you a way of looking ahead rather than simply looking at what is in the bank today.

It allows you to ask:

How much cash will we have in the coming weeks and months?

And, importantly:

Will there be enough to pay what we need to pay?

 

What is a cash flow forecast?

A cash flow forecast is a forward-looking view of the money you expect to come into and go out of the business.

It normally shows:

Opening cash balance

How much money you expect to have available at the start of the period.

Cash coming in

The money you expect to receive from customers and other sources.

Cash going out

The payments you expect the business to make.

Net cash movement

The difference between the cash coming in and the cash going out.

Closing cash balance

The amount of cash you expect to have left at the end of the period.

A forecast might look something like this:

At first glance, there may not appear to be an immediate problem.

The business still has money in the bank.

But the forecast is showing something important.

The cash balance is falling every month.

If nothing changes, the business will eventually run out of available cash.

That is why looking at today's bank balance isn't enough.

How do I read a cash flow forecast?

You don't need to understand every accounting term to get useful information from a cash flow forecast.

Start by looking at five things.

1. How much cash do you have now?

Look at your current available cash.

But don't stop there.

You need to think about how much of that money is actually available to use.

For example, you may have £50,000 in the bank, but if £20,000 of that is needed for an upcoming VAT payment, your available cash is not really £50,000.

Understanding what money is already committed is important.

2. How much cash is coming in?

Look at your expected customer receipts.

Then ask yourself how realistic those figures are.

Are customers paying on time?

Are you assuming invoices will be paid on a particular date when they are regularly paid later?

Do you have a small number of customers making up a large proportion of your expected cash?

If your forecast assumes £100,000 will come in next month, but your customers regularly take 60 or 90 days to pay, your forecast may be too optimistic.

A cash flow forecast is only useful if the assumptions behind it are realistic.

3. How much cash is going out?

Look at your expected payments.

This should include your normal monthly costs as well as larger or less frequent payments.

For example:

• Wages
• Suppliers
• Rent
• HMRC
• Loan repayments
• Finance agreements
• Insurance
• Stock
• Professional fees
• Equipment
• Other significant payments

Don't only look at the biggest costs.

Small regular costs can also add up and have an impact on your cash position.

4. When are the big payments due?

This is particularly important.

A business might be able to afford its annual insurance bill, for example, but that doesn't mean it is easy to find the cash for it when the payment is due.

The same applies to VAT, PAYE, Corporation Tax and other liabilities.

Make sure your forecast reflects when money actually leaves the bank, rather than simply when an expense appears in your accounts.

5. What is your lowest cash point?

This is one of the most useful numbers to look at.

Your forecast might show that you have £50,000 in cash today, but perhaps your lowest point over the next few months is only £5,000.

That tells you much more about the pressure the business could face.

You should be looking for:

When is our cash balance at its lowest?

How low does it go?

What payments cause the drop?

What happens if a customer pays late?

These questions can help you identify problems before they become urgent.

What numbers should a director be looking at?

There isn't one single number that tells you whether your cash flow is healthy.

Instead, look at the overall picture.

Some of the key figures to monitor include:

Cash in the bank

How much cash is available today?

Expected customer receipts

How much money should be coming in and when?

Debtor days

How long are customers actually taking to pay you?

Monthly cash outgoings

How much cash does the business normally need each month?

HMRC liabilities

What VAT, PAYE, Corporation Tax or other tax payments are coming up?

Loan and finance repayments

How much is committed to repayments each month?

Supplier payments

Are supplier costs increasing or are you carrying larger balances?

Closing cash balance

How much cash will you have left after everything expected has been paid?

Minimum cash balance

What is the lowest point in your forecast?

These figures give you a much clearer picture than simply checking your bank balance at the end of each day.

How far ahead should I forecast?

There isn't one perfect forecasting period for every business.

A useful approach is to have both a short term and longer term view.

A 13 week cash flow forecast can be particularly useful when you need a detailed view of what is happening over the coming weeks.

This can help you identify upcoming pressure, large payments and periods where cash may become tight.

For businesses with more complex finances, a 12 month forecast can also be useful.

This gives you a longer term view of things such as:

• Seasonal changes in sales
• Tax liabilities
• Planned investment
• Loan repayments
• Equipment purchases
• Recruitment
• Expansion
• Other significant expenditure

The further ahead you look, the less certain individual figures become.

That means you shouldn't treat a 12 month forecast as a prediction of exactly what will happen.

It is a planning tool.

The shorter term forecast should be based on as much real information as possible.

For example, if you already know when a customer is due to pay an invoice or when a VAT payment is due, that information can be built into your forecast.

What should I change if my cash flow is getting worse?

This is where cash flow forecasting becomes useful.

The purpose isn't simply to identify that there is a problem.

It is to help you understand what is causing the problem and what you can do about it.

If cash coming in is lower than expected, look at your sales and customer payments.

Ask:

• Are customers paying late?
• Are payment terms too long?
• Are you invoicing quickly enough?
• Are there old invoices that need chasing?
• Are you relying too heavily on one or two customers?

Improving the speed at which customers pay can make a significant difference to cash flow.

If cash going out is the problem, look at your costs.

Ask:

• Which costs are essential?
• Which costs have increased?
• Are there subscriptions or services the business no longer needs?
• Can supplier terms be reviewed?
• Are you buying more stock than you need?
• Are there large purchases that could be delayed?

You should also look at upcoming commitments.

If your forecast shows that a large payment is going to create pressure, understanding that early gives you more time to plan.

What if the problem is getting worse every month?

This is where directors need to pay attention.

If your forecast shows your cash balance falling month after month, don't simply wait and see what happens.

Look at why it is happening.

For example, you may be:

• Spending more than the business is generating
• Waiting too long for customers to pay
• Taking on too many costs
• Carrying too much stock
• Making large loan or finance repayments
• Using cash to fund growth
• Falling behind with HMRC or suppliers
• Relying on borrowing to cover regular operating costs

The important thing is to understand whether the problem is temporary or becoming a pattern.

A temporary cash flow dip may be manageable.

A continuing reduction in available cash needs much closer attention.

How can a profitable business run out of cash?

This is one of the most common areas of confusion for directors.

Imagine your business makes a £100,000 sale.

That £100,000 appears as revenue, but the customer doesn't pay you for 90 days.

In the meantime, you still need to pay:

• Employees
• Suppliers
• Rent
• HMRC
• Finance
• Other business costs

The business may record a profit from the sale, but the cash hasn't arrived yet.

The same issue can happen when a business is growing quickly.

You may have more customers and more sales, but growth can require you to spend more money upfront.

You might need to:

• Buy more stock
• Take on more employees
• Pay suppliers before receiving customer payments
• Purchase equipment
• Increase premises
• Spend more on marketing
• Finance larger projects

Your profit may be increasing while your cash position becomes tighter.

Profit tells you whether the business is making money.

Cash flow tells you whether you have the money available to meet your payments when they fall due.

You need to understand both.

What are the warning signs of a cash flow problem?

There are several signs that your cash flow may need closer attention.

You may notice that:

• Your bank balance is falling every month
• Customers are taking longer to pay
• You are constantly chasing overdue invoices
• You are using one source of borrowing to repay another
• You are regularly relying on your overdraft
• You are struggling to pay suppliers on time
• HMRC payments are becoming difficult
• You are making minimum payments rather than clearing balances
• You are delaying essential spending because there isn't enough cash
• Your forecast shows a future cash shortfall

One warning sign doesn't necessarily mean the business is in serious financial difficulty.

But if several of these are happening at the same time, it is worth taking a closer look at the numbers.

What should I do if my cash flow forecast shows a shortfall?

Don't ignore it.

The earlier you identify a potential cash flow problem, the more time you have to understand what is causing it and consider what can be changed.

Start by checking that your forecast is realistic.

Make sure you haven't overestimated customer payments or forgotten upcoming costs.

Then look at what you can change.

That could mean improving your credit control, reducing costs, delaying non essential spending, reviewing payment terms or looking at whether additional funding is appropriate.

If the forecast shows that the business may not have enough cash to meet its liabilities, it's important to understand the position properly rather than simply continuing as normal.

The key is to act before a cash flow problem becomes a crisis.

Cash flow isn't just an accountant's job

Understanding your cash flow is part of being a director.

You don't need to be an accountant or understand every line of a set of accounts.

But you should know:

• How much cash the business has
• How much is coming in
• How much is going out
• What major payments are coming up
• When customers are expected to pay
• What your lowest cash point is likely to be
• What happens if payments are delayed
• Whether the current position is improving or getting worse

A cash flow forecast gives you the opportunity to look ahead and make decisions based on what the business is likely to need, rather than waiting until the bank balance becomes a problem.

What if you're already struggling with cash flow?

If your cash flow is becoming difficult to manage, don't wait until you can no longer pay your bills.

Understanding the numbers is the first step.

You need to know what is causing the pressure, how serious it is and what could happen if nothing changes.

At The Directors Helpline, we provide free, confidential and independent guidance to company directors who are worried about their business finances.

If you're concerned about your cash flow or you're not sure what your numbers are telling you, speaking to someone early can help you understand where you stand and what you should consider next.

You don't need to wait until you've run out of cash to ask for help.