Cash flow is the lifeblood of your business.

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Cash flow is the life blood of any business and keeping it flowing efficiently is important to making the business sustainable and profitable.

Cash flow is simply the money that goes into and out of your bank account. It is understanding the timing of these ins and outs and what causes those timings that allows us to effectively manage our cash.

The starting place is to look at the Statement of Cash Flows in your annual financial statements, then understand operating cash flow with a concept called the Working Capital Cycle and finally, how a Cash Flow Budget supports you when managing your cash flow.

Statement of Cash Flows.
The Statement of Cash Flows addresses timing differences in your cash flow by breaking it down into 3 categories. Cash flow from:

1. Operating activities,
2. Investing activities, and
3. Financing activities.

I am going to explain each category in reverse order.

1. Financing activities.
For any business to operate and grow it needs cash to buy resources. This money usually comes from 1 of 4 sources:

i.) Owners and investors. This may be in the form of issuing shares if it is a company or owners accounts in the case of a sole trader or partnership. This will appear in the Net Worth or Equity category on the Balance Sheet.

ii.) Borrowings. Money borrowed from other people or organisations such as loans, overdrafts, leases etc that you are likely to pay interest on and will need to repay. These will appear in the Liabilities category on the Balance Sheet.

iii.) Creditors. These are organisations or individuals who provide you with goods or services before you pay for them. For example, a supplier delivers goods and issues you an invoice to pay at a later date. These will appear in the Liabilities category on the Balance Sheet.

iv.) Profits retained in the business. Profits may be distributed as dividends or drawings to the owners of the business or retained in the business. If they are retained in the business, they will appear in the Net Worth or Equity category on the Balance Sheet as it is effectively the owner’s money being injected back into the business.

The financing activities section of the Statement of Cash Flows records the increase or decrease of owners/investors’ money and borrowings over the period of the statement. Creditors/accruals and profit are generally accounted for in operating activities.

It is important to note that while we are talking about cash for these categories, when they are reported on the Balance Sheet or Statement of Cash Flows they may no longer be cash as the money may already have been spent on the assets of the business.

2. Investing activities.
Every business needs resources to operate. We generally categorise these as assets or expenses on our financial statements. Investing activities generally relates to the resources that are classified as fixed or non-current assets such as land, building, motor vehicles, equipment, office equipment, intellectual property etc.

Investing activities records the purchase or sale of these assets over the period of the statement.

3. Operating activities
Profit is not cash.
The main purpose of a business is to make a profit. The Income or Profit and Loss statement records actual income for the period and matches the costs/expenses associated with those sales for the period to determine profit.

However, when you make a sale you may not collect the cash at the same time. You may have taken deposits, which will appear as a liability on your Balance Sheet and called income in advance, or issued an invoice for payment at a later date which would appear on your Balance Sheet as an asset called debtors or accounts receivable. The Statement of Cash Flow will adjust sales by the change in these Balance Sheet items to determine how much cash was received for the period.

It is similar with your costs/expenses. You may purchase goods or stock prior to when you sell them. These will be included on your Balance Sheet as an asset called inventory or stock until the time of sale. The Statement of Cash Flow will adjust Cost of Sales by the change in these Balance Sheet items to determine how much cash was paid for the period.

If any organisation or person provides you with goods or services and you are allowed to pay at a later date via an invoice, contract or legislation, these will appear as liabilities on your Balance Sheet called creditors, accruals, provisions or a more descriptive title. Alternatively, if you pay in advance the expense will appear as an asset and be called prepayments. The Statement of Cash Flow will adjust costs/expenses by the change in these Balance Sheet items to determine how much cash was paid during the period.

Any non-cash items such as depreciation will also be removed from expenses to calculate your cash flow from operating activities.

Cash flow from your operating activities plus or minus cash from investing activities plus or minus cash from financing activities should equal the change in your cash from the beginning of the period until the end of the period.

While the Statement of Cash Flows can give you some great insights into what happened to your cash during a period, it is less insightful on how to manage it, particularly in regard to your operating cash flow.

Working Capital Cycle
Another way to look at cash flow from operations is the Working Capital Cycle. The Working Capital Cycle helps you think more about how the cash flows through your business.

Working Capital Cycle

We start with the cash in your bank account.

You then use the cash to buy resources. Then you add value to those resources and sell them. Those resources may be stock or raw materials, but they can also be employees, marketing, utilities, rent, accounting and the other costs and expenses of the business.

What we are interested in, is the amount of time between purchasing these resources and selling our goods and services. This time may be taken up in a number of different ways depending on your industry. The activities that use up time could include researching, manufacturing, delivery, installation, distribution, and many more.

Let me illustrate why time is important. If I pay $10 cash for stock, I am out of pocket $10 which I would need to fund from my own resources (equity) or borrow.

If I sell that stock the same day for cash, I get my $10 back almost immediately, hopefully with some profit as well. I can then pay the $10 back to the owner or lender. Or I can use it again, send it through the Working Capital Cycle again, to buy another $10 of stock to sell tomorrow. This is called just in time stock management.

However, it’s different if there is a time delay before I can sell the stock. Let’s say there is a delay of 5 days. I now need to buy enough stock to meet 5 days of sales. If daily sales are $10 worth of stock, I now need to buy $50 worth of stock to ensure I can meet my sales. I am now out of pocket $50 which I would need to fund from my own resources (equity) or borrow.The longer the period between purchasing resources and making sales the more money the business needs to fund these resources.

The above example assumes we receive cash at the time of sale. For many businesses they sell on credit. This means instead of receiving cash they issue an invoice for payment at a later date. The longer these customers take to pay, the more funding the business will require to continue to operate. The impact of time taken to receive payment is similar to the time taken to move resources that we looked at earlier. Each extra days’ worth of sales adds to the amount of funding required.

Every business has a Working Capital Cycle. It is important to understand how yours works and how long it takes for your dollar to go around the cycle. 

Cash Flow Budget
Another useful tool to manage cash flow is a Cash Flow Budget.

Unlike a profit forecast, the Cash Flow Budget estimates the timings of when cash will be received from sales and when payment will be made for expenses. In other words, when cash will go into the bank account and when cash will come out.

A Cash Flow Budget forecasts how much cash or how little cash you may have in the future allowing you to prepare.

If the budget shows that you may have a cash shortfall in the future, you could make changes to the business now or organise the funding you may need. Without a forewarning from a budget, you may not have time to make changes to your business, and if you are able to obtain funding, it may cost you more with higher interest rates or fees from the lender.

Understanding how cash flows through your business, may help you better understand how your decisions impact your business and may lead to a more efficient use of cash with the aim of making your business more sustainable in the long run.


This information is general in nature and has been prepared without taking your objectives, needs and overall financial situation into account. For this reason, you should consider the appropriateness for the information to your own circumstances and, if necessary, seek appropriate professional advice. ©Westpac Banking Corporation ABN 33 007 457 141 AFSL and Australian credit licence 233714.


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Rob Lockhart

Rob has helped thousands of people and organisations improve their financial confidence. His career started almost 40 years ago working with a mid-tier accounting firm. From there he moved into banking and has worked with people and organisations. As a CPA grounded in the realities of finance, he brings a unique insight and understanding to the numbers behind our lives.

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