Cash flow is one of the most important financial aspects of owning a business in the UK. It simply refers to the amount of money being flown into and out of the business over a specific period of time. Cash flow plays a significant role in the financial growth and stability of a business. So if you are planning for a startup in the UK, looking to scale your business and bring your entrepreneurial journey, understanding cash flow is essential.
Here’s what you need to know about cash flow.
What Is Cash Flow?
In its true form, cash flow refers to the net cash/amount that a business is generating (revenue) as well as the amount the business is spending (expenses). It tracks the total amount of money coming in and going out of a business account, not just profits and sales.
Cash flow is further divided into Cash inflows and Cash outflows.
- Cash Inflows are the total revenue that a business generates from product/service sales, loans, investments, grants, and asset sales.
- Cash outflows refer to the total expenses or costs spent by a business on its rent, salaries, supplier payments, utilities, VAT, and taxes.
Types
There are three main types of cash flows;
- Operating – It is the cash flow of a business because of its operations, i.e. sales of products and/or services.
- Investing – It is the cash flow coming in from the business investments, i.e. equipment, property, or selling assets.
- Financing – It is the cash flow that relates to borrowing/repaying loans, issuing shares, or paying dividends.
Cash flow vs Profit
Most people confuse Cash Flow with Profit. However, in reality, both have completely different meanings. Profit is the amount left for a business after deducting all of its expenses and taxes from the revenue generated. On the other hand, cash flow is the total amount of money that moves in/out of the business.
Positive vs Negative Cash Flow
Understanding the difference between positive and negative cash flow is the key to business success.
Positive Cash Flow
Positive cash flow occurs when the total amount of money coming into the business (revenue) is more than the total amount going out (expenses). For example, if a business generates £50,000 and spends £35,000, it has a positive cash flow of +£15,000 (profit).
Positive cash flow of a business helps in financial stability and the growth of the business. You can repay loans, reinvest the excess amount generated for more capital and build cash reserves.
Negative Cash Flow
Negative cash flow happens when the total amount of money a business generates (revenue) is less than the total amount spent (expenses). For example, if a business generates £35,000 and has expenses of £50,000, it has a negative cash flow of £15,000 (loss).
Negative cash flows, in the longer run, can lead to business disaster as the operating costs become higher and profits become negative.
Why Cash Flow Matters?
Cash flow plays a decisive role in the success of a business. It;
Ensures business survival
A strong cash flow has an important role in business survival, regardless of how small or large your business is. Without a sufficient cash flow, you can struggle with paying salaries, rents, utilities, purchasing inventory and equipment, as well as meet tax requirements.
Helps manage growth
Growth in business requires cash. The more capital you put in, the more profits you will make and expand your business operations. With a strong cash flow, you can increase stock levels, invest in business innovations and enhance the overall customer experience.
Supports financial planning
Cash flow provides a live overview of your business’s financial position in the market. So that you can predict your future moves for better income, identify potential shortfalls, optimise your tax payments and Secure financing.
Builds investor confidence
Investors and lenders both look at business cash flows before they put money in your business. Having a strong cash flow can not only build investor confidence but also help you negotiate better credit terms.
Prepares for market uncertainty
Uncertainty in business is a common thing. If your business has a strong cash flow, you can easily manage market downtime, weather downturns, deal with rising costs and guarantee business continuity despite the conditions.
Examples
Consider a clothing shop in Leeds that generates a revenue of £25,000 in its monthly sales. The expenses of the business are £22,000. Therefore, the cash flow of the business is positive, i.e. +£3,000 and indicates that the business is generating profit.
On the other hand, if the same business generates a revenue of £22,000 while its expenses are £25,000, it has a negative cash flow, i.e., £3,000, which indicates the business is going into a loss.