Cash flow is an essential consideration for any business. Cash flow is often described as the life blood of the organization, and companies need to make sure they have enough cash coming in to meet upcoming financial obligations. However, cash flow can fluctuate over time for a number of reasons, and companies need to be aware of the risks that can arise from a negative cash flow situation.
So what is cash flow, why is positive cash flow important – and how can treasury teams benefit from a greater focus on activities such as cash flow forecasting and cash flow matching?
What is cash flow?
Cash flow can be defined as the actual amount of cash coming into and out of a business at a particular time. Cash inflows include the company’s sales revenues as well as other types of income such as interest and royalties. Cash outflows, meanwhile, include staff salaries and payments to suppliers.
Cash flow can broadly be categorised into operating cash flows, investing cash flows and cash flows from financing:
- Operating cash flows – cash flows related to business operations
- Investing cash flows – cash flows resulting from investment-related activities.
- Cash flows from financing – cash flows arising from capital raising activities.
Cash flow vs profit
Is cash flow the same as profit? In a word, no. Profit is the difference between operational income and expense, which is only part of the cash flow equation. Cash flow also includes other factors such as investments, debt, dividends and other relevant cash flows.
Should I care about cash flow?
Yes! Cash flow is important because companies need to have enough cash coming into the business to meet obligations such as payroll, taxes and operating costs. This is not always the case, however: cash flows can be either positive or negative. As such, companies need to keep a close eye on their cash flows and take action if necessary.
Positive cash flow definition
So what is positive cash flow? In short, a positive cash flow means that more cash is coming into the business than leaving it. Conversely, if a company has a negative cash flow, more money is leaving the business than entering it.
A company that has a positive cash flow will be seeing an increase to its assets on hand. As such, companies with a positive cash flow should not only be able to meet their upcoming obligations, but might also be looking to put their excess cash to work. Companies with too much cash might consider the following:
- Pay down debt
- Invest in the business, for example by purchasing new equipment or embarking on M&A activity
- Invest in the financial markets
- Increase dividends
- Keep cash readily accessible for future investment or growth opportunities, or to offset an expected period of negative cash flow.
Cash flow positive vs profitable
As already noted, cash flow is not the same as profit. While cash flow indicates how much money is coming into and out of the business, profit is a measure of how much money remains after all expenses have been paid. As such, having a positive cash flow does not necessarily mean that a company is profitable, or that it has a positive net income.
In fact, a company can have a negative net income and positive cash flow – for example, if the company receives a large cash inflow as a result of debt issuance despite posting a loss during the relevant period.
Conversely, a profitable business may still experience cash flow challenges. For example, if customer payments tend to be delayed this can make it difficult for a business to meet its financial obligations on time.
Can cash flow be negative?
While a positive cash flow is the desired situation, cash flow can also be negative if the company is spending more cash than it receives – meaning that action may need to be taken to boost sales or reduce operating expenses.
Likewise, if a company’s cash flow is negative, its liquidity is decreasing – which means questions need to be asked about whether the company is likely to fall short of its desired liquidity position. If this is the case, the following options may need to be considered:
- Put in place long-term debt or access the capital markets, for example by issuing commercial paper
- Sell existing investments
- Utilize short term borrowing, such as a credit facility
However, it’s worth noting that negative cash flow is not always deemed to be a problem – for example, investing in future growth can sometimes result in a negative cash flow. Equally, negative cash flow is a common situation for new businesses – albeit one that needs to be monitored carefully.
How can cash flow be managed more effectively?
If you’re looking to plan more effectively and manage your cash flow, it’s important to look at the options available – such as cash flow matching.
Cash flow matching is a technique whereby the company looks at the expected outflows and inflows of the business, and makes sure that financial instruments and their cash flows are aligned with business trends, and there are cash flow forecast software tools out there that can assist.
For example, the company might be planning to use business operations to fuel the repayment of debt. In this situation, debt maturity should not be scheduled on May 15 if the cash flow expected to fund the repayment is not due until May 30.
What is the goal of cash flow matching?
Cash flow matching is a way of managing cash flows by avoiding unnecessary gaps in liquidity that might arise due to the timings of cash inflows and outflows. Where necessary, companies can use their financial flows to supplement operational negative cash flows.
How can treasury perform efficient cash flow matching?
For treasury teams, there are a number of points to consider when combining efficient cash flow matching with capital planning.
Most importantly, treasury teams should focus on the following:
- Up-to-date information. It’s essential to have access to up-to-date, accurate information about the company’s current cash balances, as this will form the basis of a cash flow matching exercise. By taking advantage of modern treasury technology, companies can access real-time cash balance data from their banks.
- Accurate forecasting. Likewise, the treasury team needs to have a clear and accurate forecast of the business’ future cash inflows and outflows. This can be challenging to achieve, as it involves sourcing data from different parts of the organization, and collating data on upcoming payables and receivables. Companies need to have the right processes and systems in place to access forecast information before it becomes out-of-date.
- Integration of financial instrument cash flows. In addition, companies need to make sure they are able to incorporate cash flows arising from existing financial instruments into the cash flow matching exercise to make sure all relevant data is taken into account.
In conclusion, cash flow is a vital consideration when looking at the health of the business – and there is much that businesses can do to optimize their cash flow position and drive a positive cash flow, including harnessing up-to-date information in order to carry out cash flow matching. Companies facing cash flow challenges will need to consider which course of action is best suited to their current needs.