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Cash Flow

Understanding Cash Flow - A Critical Business Priority

Cash flow represents the lifeblood of any company. It is the net amount of cash being generated and consumed by the business over a period of time, usually measured monthly or quarterly. Understanding and optimizing cash flow is a critical priority for business leaders seeking growth and sustainability. 

Defining the Main Types of Cash Flow 

There are two primary types of cash flow to understand:

Operating Cash Flow

Operating cash flow indicates the amount of cash being produced from the core business operations and activities. It is calculated as:

Operating Cash Flow = Net Income + Adjustments 

The "adjustments" include non-cash items like depreciation, changes in working capital and gains/losses on asset sales. Operating cash flow excludes cash from outside investing or financing activities and focuses solely on the company's core business engine. It represents the primary means of generating cash through sales and operations.

Free Cash Flow

Free cash flow (FCF) refers to the cash remaining after a company has made necessary investments to maintain or expand the business. It accounts for capital expenditures and is calculated as: 

Free Cash Flow = Operating Cash Flow - Capital Expenditures

FCF represents the true discretionary cash available for purposes like paying dividends, repurchasing shares, pursuing growth opportunities or building up reserves. Companies aim to generate sufficiently high FCF to fund growth without taking on excessive debt.

Analyzing Cash Flow Performance 

Analyzing cash flow is critical for assessing a company's financial health and performance. Key analyses include:

Cash Flow Reporting 

Regular cash flow reporting provides visibility into the timing and amounts of cash being generated and used. The primary report for this is the Statement of Cash Flows which categorizes the sources and uses across operating, investing and financing activities.

Cash Flow Trend Analysis

Looking at cash flow trends over recent periods identifies growing or declining cash generation patterns. This helps diagnose the timing of cash flow changes and determine underlying drivers.

Comparison to historical averages and past performance benchmarks helps assess the state of cash flows.

Cash Flow Forecasting

Cash flow forecasts aim to predict future cash positions and surpluses/deficits based on assumptions, budgets and projections. Building 18-24 month cash flow forecasts helps anticipate cash needs for growth plans and operating requirements.

Cash Flow Ratio Analysis

Key ratios for evaluating cash flow include:

- Cash ratio - assesses liquidity using cash and marketable securities over current liabilities

- Cash flow margin - compares operating cash flow to revenue 

- Cash flow yield - indicates operating cash flow generated per dollar of market capitalization

- Cash conversion cycle - measures how long cash is tied up in working capital 

These ratios spotlights potential deficiencies and changes in cash flow performance. 

All these analyses ensure visibility into both current cash positions and anticipated future cash generation.

Driving Cash Flow Performance Improvements

When facing cash flow challenges, businesses must take action to improve their cash position. Key strategies include:

Increasing Operating Cash Flow

- Grow sales volumes by expanding marketing reach and implementing promotions

- Raise pricing gradually in line with customer willingness to pay

- Develop higher-margin products and revenue streams

- Upsell and cross-sell to existing customers to grow wallet share

- Tighten credit policies and accelerate collections to improve working capital velocity

Reducing Capital Expenditures

- Critically evaluate all CAPEX and prioritize investments with the highest ROI

- Shift toward less capital-intensive business models if feasible 

- Extend useful life of existing assets through maintenance and enhancements

- Consider used equipment purchases or leases to lower outlays

Lowering Costs 

- Reduce COGS (cost of goods sold) through economies of scale, supplier negotiations, automations and production innovations

- Lower SG&A costs by optimizing overhead, leveraging technology and improving efficiency 

- Manage inventory tightly to minimize holding costs and waste

- Renegotiate contracts and payables to extend payment terms

Exploring Financing Options

- Consider business loans, lines of credit or asset-based lending to bridge near-term cash needs

- Offer trade credit or favorable financing to customers to boost sales

- Involve partners or investors to fund growth plans in exchange for equity

- Leverage government incentives, grants, tax credits to reduce cash outlays

These levers focus on boosting operating cash flow, reducing capital investment, lowering costs and supplementing with financing.

Multi-pronged approaches are often required to turn around cash flow problems.

Implementing Strong Cash Flow Management

Beyond diagnosis and improvements, businesses need to implement strong ongoing cash flow management practices:

  • Centralize visibility into cash positions with treasury management systems
  • Build rolling 18-24 month cash flow forecasts updated monthly
  • Set key cash flow ratio targets and benchmarks to meet 
  • Review weekly cash positions and daily cash balances to spot fluctuations
  • Manage exposures with currency hedges and insurance where prudent
  • Accelerate invoicing and collections processes for faster inflows
  • Take prompt advantage of supplier discounts to extend outflows 
  • Institute approval controls and budget thresholds to control outlays
  • Target quick turnaround of excess inventory into cash
  • Maintain adequate credit reserves and contingency funds

With rigorous cash flow management, businesses can respond quickly to changes or shortfalls before they become dire.

This enables financial stability and support for growth plans.

Make Cash Flow a Priority

Cash flow requires consistent priority focus across analysis, improvements and management practices.

Declining or volatile cash flows place tremendous stress on organizations.

Developing a cash flow optimization culture focused on maximizing inflows while prudently managing outflows is key to success.

With robust operating cash flow and disciplined deployment of free cash flow, companies gain the financial means to pursue their goals.

To learn more proven cash flow management strategies, explore our [cash flow courses] taught by expert Chartered Accountants.

Sub-optimal cash flow need not be a barrier to your business goals.