What is cash outflow, and why is managing it important
Cash flow can be defined as the flow of money in and out of businesses during a period and needs to be monitored closely. While the receipt of money is known as cash inflow, any movement of cash out of the business is called cash outflow.
Cash outflow is determined by the cash or cash equivalents moving out of the company. It refers to the amount of cash businesses spend on operating expenses, debts (long-term), interest rates, and liabilities.
Examples of cash outflow include salary paid to employees, dividends paid to shareholders, reinvestment in business, rent paid for office premises, and more.
Cash inflow is the exact opposite of cash outflow.
Cash inflow defines the amount of money the company earns through any activity that leads to revenue generation. A common example is the money generated from the sale of goods and services. Moreover, return on investment, financing, and positive investments lead to an influx of money.
When the total cash inflow exceeds the total cash outflow, the company has a positive net cash flow and vice versa. A positive cash flow means the company has enough money to cover its expenses and invest in the business’s growth. It also determines the business’s ability to generate value for its shareholders.
Cash inflow and cash outflow are interconnected. For instance, you sell 10,000 units of your product. Now, this will lead to an influx of cash (cash inflow) for your business. However, you would’ve also spent money (cash outflow) on raw materials, equipment, labour, and more during the production stage.
The difference between your inflow and outflow will determine whether you have a positive or negative net income. Since your business’s financial health depends on its ability to generate cash, it’s crucial to minimise cash outflow and overcome cash inflow problems.
Usually, a company’s cash flow statement showcases outflows from the following three activities:
Cash outflow from operating activities refers to the money you spend on your regular activities—the production of goods and services.
For instance, salaries and wages paid to employees, payment to suppliers of raw materials, maintenance costs related to plant and machinery, rent, income tax, utilities, and sales and marketing all come under operating expenses.
Cash outflow from investing activities includes money spent on numerous investment-related activities. Simply put, any money you spend on the purchase of an investment (non-current asset) will fall under this category. Generally, the investing cash outflow exceeds the inflows.
Cash spent on the purchase of plant and machinery or other fixed assets and loans to other businesses fall under investing expenses.
Cash flow from financing activities relates to funds spent to finance the company and its operations. This pertains to non-current liabilities and shareholder’s equity. Examples include paying dividends to shareholders, clearing long-term debts, and buying back shares.
These activities form the backbone of a cash flow table and provide insights into a company’s expenditure.
To calculate your company’s cash outflow, you must add all its expenses during a period (month, quarter, or year).
Calculating total cash outflows from all the activities is quite simple. All you need to do is calculate cash outflow from each of the activities individually and then add all the activities to get the desired figure.
This is the formula for calculating the total cash outflow from all the activities:
Total cash outflow = Cash flow from operating activities + Cash outflow from investing activities + Cash flow from financing activities
For instance, if your cash outflow from:
Operating activities = £10,000 Investing activities = £20,000 Financing activities = £15,000
Then, your total cash outflow = £(10,000 + 20,000 + 15,000) = £45,000
Net cash flow is the difference between the cash inflows and outflows of a business.
Net cash flow = Total cash inflows - Total cash outflows
Net cash flow = Net cash flow from operating activities + Net cash outflow from investing activities + Net cash flow from financing activities
Since cash is one of the most essential components of a business, it’s important to chart methods and adopt cash flow management techniques to manage cash effectively. Cash management involves monitoring both cash inflow and outflow.
However, managing cash outflows will give you a complete picture of the cash transactions that lead to money moving out of the organisation.
It involves tracking and managing all business liabilities to locate venues where you can cut down unnecessary expenses and formulating strategies to fulfil your obligations on time without putting undue stress on your working capital or other resources.
- Having a clear picture of your business’s expenses.
- Deep insights into your company’s performance.
- Optimising cash to ensure you don’t run out of it.
- Locating areas where you can reduce expenditure to curb overspending.
The most common challenges associated with cash outflow management are:
- Disorganised records: This is perhaps the most common cash outflow management challenge since it’s important to maintain and store clear records of all your cash expenses.
- Managing accounts payable: Having visibility of your accounts payable is crucial. You should be on top of all expenses and determine strategies to cut down unnecessary costs.
- Payment of bills: While you shouldn’t renege on deals and honour prior commitments, pay your bills when they’re due and not as soon as you receive them. It’ll be tempting to pay your dues earlier to get in your supplier’s good graces, but resist the temptation and pay your bills when they fall due unless you receive trade discounts. In that case, try availing the discount as much as you can. Stretch your working capital to make the most of the resources available.
- Tracking cash outflow manually: Though you’ll save money if you meticulously track your cash outflows in Excel, investing in cash flow management software will help you automate the process, reduce the chances of errors, and take a weight off your shoulders.
Cash outflow analysis is essential to understand the amount of money that’s moving out of the company. Further, it highlights the amount spent on each activity.
For instance, just knowing your total cash outflow for a month is £1,00,000 isn’t enough. This doesn’t give you a complete picture of where your money is going—what percentage of your profit you’re apportioning to each item.
But if you’ve got a detailed breakdown of this expenditure, such as £30,000 for rent, £40,000 for salaries and wages, and the remaining £30,000 for day-to-day operations, you can analyse these expenses to determine the avenues where you’re probably spending more than you should or where you can control or reduce costs.
Armed with this knowledge, you can forecast your cash outflow based on past expenses and make informed decisions. This will help CEOs and CFOs project the amount of money they need to tackle their expenses head-on for the coming period (forecasted time period) and if they need to look into alternate sources of capital to finance their operations.
For an accurate cash outflow forecast, estimate your expenses for the coming period. Consider occasional expenses, such as replacement costs for broken-down fixed assets, to be prepared for the worst.
Managing and optimising cash outflow is essential for all businesses to improve their profit. Listed below are some of the adjustments that will benefit businesses:
- Considering opportunity cost: No capital is free. This holds true when you reinvest your profits, borrow capital from your investors, or take on debt. Since the capital you’ve got or are borrowing isn’t free, investing or spending it in venues where it’ll create the most value for the business and society makes sense. For instance, if you’re spending money on replacing fixed assets like plant and equipment, ask yourself if the money can be put to better use if you got the assets repaired instead of replacing them.
- Take a deep dive into your expenses: Determine whether your business is optimising cash outflows to maximise profits, the long-term assets are generating value or sitting idle, and employee expenses are being monitored or approved without due diligence.
- Have liquid funds: While it’s a sound strategy to invest your financial resources in assets and spend them to generate more value in the future, you need to have liquid funds to meet short-term obligations. You don’t want to default on your utility bills or pay your suppliers late, as you’ll have to bear late charges, and it’ll also strain your relationships with your suppliers. Moreover, not paying your employees on time will lead to a loss of trust and might even result in lower efficiency.
- Renting instead of buying: If you’re starting out and don’t have a lot of cash to burn, it’d be better if you rent property and equipment rather than paying for them upfront, incurring huge cash expenditures and emptying out your bank account. This is especially useful for small businesses and startups. You won’t just benefit from smaller upfront expenditures but also have leftover cash to tackle other business expenses.
Minimise operating costs: Finally, take steps to review, analyse, and forecast your cash outflow so that you can find venues to bring down your operating expenses.
Find ways to cut down your expenses, but not in ways that will affect your business down the line. For instance, negotiating a lower rent for your office or better payment terms with your suppliers will have a positive effect on your cash outflow. However, diluting the quality of your goods and services will save you money initially but cost you dearly down the line since you’ll lose your hard-earned customers.
Let’s see how cash outflow management differs for various business sectors.
Startups and small businesses don’t have access to unlimited financial resources, so they need to stretch the cash they’ve got to make the most of their capital. Keeping track of all expenses—big or small—is essential to maximise profits and minimise unnecessary cash outflows.
A rule of thumb is to have enough cash left after expenses (cash outflow) to cover the operational costs for the next three to six months.
Though established corporations have more financial freedom, they have a greater responsibility to create value for their shareholders and maximise their equity. So, they need to consider opportunity costs and study reports from various departments before making cash outflow decisions or approving expenses.
Cash flow optimisation is crucial for all businesses, but it can be taxing to monitor, manage, analyse, and forecast it on your own. This is where tools like Agicap come in. It provides data analytics to provide deep insights and help you make informed decisions. Moreover, it supports automation and integration with financial systems.