If, as many experts agree, that the golden rule of business is "cash is king," then happiness in business is a positive cash flow. Cash flow is the movement of money in and out of your business over a defined period of time (weekly, monthly, or quarterly). If cash coming into your business exceeds the cash going out of your business, your company has a positive cash flow. However, if your cash outflow exceeds the cash inflow, then your company has a negative cash flow. To create a positive cash flow, generate more cash and collect the cash in a more timely manner and at the same time, maintain or reduce your expenses.
Positive cash flow does not happen by accident; it happens because a well-defined financial management technique called "cash management" is functioning. A good cash management system helps to efficiently and effectively manage the activities that produce cash. Maintaining an optimal level of cash that is neither excessive, nor deficient is of the upmost importance. Accelerating cash inflows wherever possible is a mandatory practice. Two activities that accelerate cash inflows include invoicing customers as quickly as possible and collecting cash on past due accounts. Delaying cash outflows until they come due is a critical step in good cash conservation. Negotiating extended payment terms with suppliers also delays cash outflows. In addition, investing surplus cash to earn the highest rate of return is a good business practice.
In order to understand the magnitude and timing of cash flows, plotting cash movement, with the use of cash flow forecasts, is critical. A cash flow forecast provides you with a clearer picture of your cash sources and their expected date of arrival. Identifying these two factors will help you to determine "what" you will spend the cash on, and "when" you will need to spend it.
Your financial reporting documents should include an Income Statement, a Balance Sheet and a Statement of Cash Flows. Your "cash flow forecast" reflects the same three types of cash flow activities that appear in your Statement of Cash Flows. The three types of cash flow activities are:
o Cash Flows from Operating Activities: This is the cash flow that is generated which is the direct result of the sales of your product/services.
o Cash Flows from Investing Activities: This is the cash flow that is generated from non-operating activities, such as, investments in plant and equipment or other fixed assets.
o Cash Flows from Financing Activities: This is the cash flow that is generated from external sources--- lenders and investors.
These three types of cash flow activities are interrelated. They depend on, and affect each other. The cash flow forecast should take this into account, and provide a complete picture of where cash will come from and how it will be used for the period being forecasted. The relationships between the different cash flow activities may depend on the nature of your business, the stage of development of your business, as well as, general economic conditions, or conditions within the market or industry in which your business operates.
Cash outflows and inflows seldom occur together. In most cases, cash inflows seem to lag behind cash outflows, leaving your business short on cash. This shortfall is your "cash flow gap." The cash flow gap is the period (number of days) between your business payment of cash for goods and services purchased, and the receipt of cash from your customers for goods or services sold. In other words, inventory days on hand + receivables collection period - accounts payable period = the cash flow gap. This interval, the cash flow gap, must be financed. Keep in mind the fact, that for each day your cash flow gap is extended, so too is the amount of interest being accrued. Even when interest rates are low, the cost of financing can add up quickly.