Why is cash flow important and how can I increase it?

How freely does your cash flow river run?

If a decent stream of money is coming in and out, it’s a good sign. If it’s a slow trickle, on the other hand, you need to encourage the rain. But why is a healthy cash flow so important? 

Here we explore the difference between cash flow and working capital, look at what can happen if your available business dollars dry up, and provide some effective strategies to increase your cash flow.  

Cash flow and working capital

Cash flow is often referenced as working capital. But while they’re both important financial concepts, they’re not the same thing. 

Cash flow refers to the movement of money in and out of your business. It measures the amount of cash your business generates or uses over a specific period, typically a month, quarter or year. 

• Positive cash flow – You’re generating more cash than you’re spending
• Negative cash flow – You’re spending more cash than you’re generating

Working capital, by comparison, refers to the difference between your business's current assets (e.g., bank, debtors, stock) and current liabilities (e.g., creditors, tax obligations). 

It represents the amount of money you have available to fund your day-to-day operations.

• Positive working capital – You have more current assets than liabilities
• Negative working capital – You have more current liabilities than assets

Importantly, a business can have positive cash flow but negative working capital if it's generating cash by selling long-term assets or taking on debt, for example. 

Similarly, a business can have positive working capital but negative cash flow if it's not generating enough cash to cover its expenses.

Working capital isn’t dependent on cash flow. In fact, it’s often used as a way to manage it. 

No cash flow; no business

No or slow cash flow can be disastrous in business for several reasons. 

Not only can it mean you aren’t able to pay your bills on time, but it can prevent investment in growth, increase debt and make it harder to attract investors. In addition, it means you have no buffer for unexpected events.

Those businesses that went into COVID cash flow short, for example, would have suffered the most as they had no funds to fall back on.  

If you’re unable to pay off your bills, you could also face formal insolvency action, including liquidation. So cash flow really is your lifeblood.

Because of this, continual planning of cash flow (and working capital) is essential. 

How to maximise or increase cash flow

There’s no one secret to maximising or increasing cash flow. 

It often requires a combination of different cash flow strategies and tactics that vary depending on the unique circumstances of your business. 

Here are some recommended best practices that can help you encourage the financial rain to fall: 

• Increase sales revenue – This can be achieved by launching new products, increasing marketing efforts, or expanding into new markets.
• Reduce expenses – Cut down on unnecessary expenses and negotiate better deals with suppliers.
• Manage inventory – Overstocking can tie up cash, while understocking can lead to lost sales. Regularly reviewing inventory levels and sales trends can help you strike the right balance.
• Access shareholder loans or equity – This allows you to access equity with more flexible terms that may not need repayment in the short to medium term.
• Utilise credit lines – Loans and overdrafts can help cover short-term cash flow gaps. However, using credit lines responsibly and paying them off on time is important to avoid high-interest charges.
• Sell business assets – Focus on non-core assets, such as unused machinery or inventory or underperforming assets.
• Improve payment terms – Negotiate shorter payment terms with your customers or ask for upfront deposits.
• Purchase stock on consignment – Your supplier retains ownership of the goods until you sell them. Once sold, your supplier receives a portion of the revenue generated from the sale.
• Control shareholder payments – Be disciplined in how shareholders withdraw money from the company over and above any salaries paid. Stick to fixed regular payments and/or adopt a dividend policy to ensure you’re not drawing out more than you should.

Beware if you’re considering stopping paying your bills to improve cash flow and working capital. While this can provide you with the extra cash you need in the short term, it can cause severe future complications.

If stopping paying bills seems like one of your best options right now, it could be a sign your business is in trouble, so take action. 

Keep your cash river flowing

Without cash flow, your business cannot function. When insufficient money is coming in and going out, you can end up high and dry and facing some hard decisions.  

By exploring which of these cash flow strategies could work best for you and implementing them, you give yourself the best chance of staying afloat. 

If your cash flow could be healthier and you would like some tailored advice, reach out to your Maxim advisor or contact our team.