Cash flow provides a better understanding of a firm’s liquidity, flexibility, and overall financial health. Business activities generally involve cash inflow via income from sales revenues and cash outflow via fixed and variable expenses. For a business to be cash flow positive, its cash inflow should exceed the cash outflow. Positive cash flow is essential for any business to survive, prosper, and sustain long-term growth.
Cash flow positive: What is it?
Cash flow positive simply means more cash coming in than going out. This metric indicates that a business has enough working capital to cover all its bills and will not need additional funding.
Additionally, a consistently positive cash flow infers that the business can add to its assets and create value for its shareholders.
The reasons why positive cash flow is vital for a business, are:
- Helps make better decisions for the future: Knowing the exact amount of money going in and out of the company allows its management to make decisions based on accurate information. Being cash flow positive provides the platform to make significant purchases for the company's future.
- Helps in taking expansion decisions: Business expansion can be risky, as it involves spending large amounts of cash required to grow a business. Effective cash flow management indicating a positive cash flow can help an organisation's leaders determine the most appropriate time for expansion.
- Helps maintain good business relationships with third parties: Being cash flow positive can avert awkward situations where there aren't enough funds available to pay suppliers, contractors, or other third parties and help maintain a good relationship with them.
How do you make your business cash flow positive?
To become cash flow positive, liquid assets or cash generated from the company's operating activities must exceed the money spent to keep it running. If your business is struggling with cash flow, here are a few measures to make your business cash flow positive:
- Maintaining a buffer fund: The first pillar of positive cash flow is always to be prepared for the worst. That’s why it’s essential to have some buffer cash on hand. Most accountants usually advise a minimum of one month’s operating expenses as an available cushion or at least have enough money to cover the next payroll period.
- Improving your receivables: Outstanding invoices and delayed client payments are the biggest cash flow hurdles, especially for small businesses. Measures can be taken to improve cash collection by encouraging clients to pay on time (follow-up and execute late penalties on invoices) and being proactive about payment collection (setting up online payments and auto-pay functions).
- Managing your payables: You can negotiate your accounts payable with vendors. Restructuring your payments to vendors creates a more balanced income for your business. Also, cut unnecessary expenses that do not add value to your business.
- Paying taxes regularly: Evade a windfall of expenses by assessing and regularly paying off estimated income taxes to the state and federal authorities every quarter.
- Reviewing business operations: Several business operations can be reevaluated and updated for efficiency. Identifying processes that can be outsourced helps in substantial cost-cutting. Apart from outsourcing, you should continuously monitor, evaluate, and improve other areas of operation to determine efficiency gaps to enhance savings.
- Managing inventory effectively: Effective inventory management is critical to improving cash flow. Particularly for a small business, inventory is equivalent to cash; the business owner should adjust inventory as needed and turn inventory quickly.
- Reviewing finance/loan options: Various options available for financing to obtain extra funds should be carefully evaluated. Options, such as loans from banks/non-banks, invoice financing, invoice factoring or business line of credit, must be weighed carefully before you finally zero down.
Does positive cash flow imply that the business is profitable?
Cash flow positive vs profitable: Cash flow is the cash a company receives and pays, but profit is the total revenue after disbursing all business expenses. Although being cash flow positive in most situations implies that the company is incurring profits, the two aren't the same.
Sometimes, a business can be cash-flow positive but may not be profitable For instance, if a business operates at a net loss, borrowing cash helps create a positive cash flow. Similarly, when it sells a significant asset to raise capital, the money it receives is an inflow of cash. In both cases, the business is cash flow positive but not profitable.
Similarly, in the case of a start-up business, a positive cash flow doesn't necessarily prove that the company is profitable. The liquidity could result from factors other than profit (loan funds or stocks sold at a loss, etc.).
- Cash flow positive vs break-even: The break-even point is when the business's profit equals zero, and cash flow is neither positive nor negative. At this point, the total cash outflow equals the business's cash inflow.
- Cash flow positive vs negative: Cash flow is deemed negative when a business has more cash outgoing than the money coming in. In a cash flow negative situation, a company cannot cover its expenses from its sales alone. Instead, it requires funds from assets and financing to bridge the difference.
Being cash flow positive implies that the business is liquid or solvent. Businesses should ensure that their revenues exceed expenses, creating a positive cash flow and generating profit.
While there’s no magic wand or switch you can flip to turn your business cash flow positive overnight, you can surely take the needed steps to manage your cash flow.
Becoming and remaining cash flow positive is a long-term business journey. Remaining alert, frequent cash flow monitoring and tracking, and making all necessary corrections shall eventually take you there.