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Cash flow 101: Plan, plan, plan

By Beatrice Thomas

Cash flow is king because it is often a business’s most important asset and without it, profitable firms can go bankrupt.  

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Cash flow is the net amount of cash coming in and going out of business as it operates.  

At the most fundamental level, a companys ability to create value for shareholders is determined by its ability to generate positive cash flows, or more specifically, maximise long-term free cash flow.  

A big mistake many business owners make is thinking that profit is equal to money in the bank.  

Cash flow and profit, whilrelated, are different concepts and understanding how each arises is imperative to operating a business well financially.  

KPMG Enterprise Partner in Charge Agnes Vacca says it is unfortunately too familiar for a promising enterprise to fail because of lack of understanding of cash and what is cash flow.   

“It is a real shame when a business which has sound profit fundamentals and growth potential comes unstuck because owners don’t have tight control of their money coming in and going out, and a lack of understanding of where the money is locked up in their balance sheet,” she says.  

She explains the most critical point for a 101 guide to cash flow is to “plan, plan and plan” for expenses - especially those “lumpy bills” and have a contingency for those costs that arrive unexpectedly, like a major repair. 

“So, what it means is that you are continuously planning and forward looking 12-18 months to see the impact of operations on cash flow and ensuring there is also a buffer for unforeseen expenses,” she says 

These could be unexpected capital requirements or personal family expenses of the owners that are funded as special dividends.  

All expected outflows should be included in the plan, even owners’ drawings if these are being funded by the business, and the forecast should reflect the actual timing of when money is being received and paid out.”   

Vacca says it’s also important you understand that a cash flow forecast is not the same as a budget.   

“A budget is the anticipated income and expenses you set at the beginning of the year, used to analyse the business’s performance,” she says 

It looks at the profitability of the company, how revenue is being generated and how expenses are managed.  

“A cash flow forecast includes all income and expenses but also the capital expenditures, tax obligations and loan repayments. 

So, if owners withdraw money out of their business for their lifestyle, other than wages, this should be included as part of a cash flow forecast but would not be reflected in the business’s operating budget.  

This will enable the business to see the effect the cash withdrawal will have on the cash balance in the next three to four months, or even longer.” 

Vacca says a successful business will be disciplined to update its financial outlook each month to account for growth, tax liabilities and external loan reductions.  

“A cash flow forecast should reflect opening cash and closing cash for each month, and you should be able to see what the cash balance looks like in months to come after paying a major bill like income tax today,” she says 

This, however, would not reflect in a budget, because income tax is not an operating expense.  

This is where people sometimes go wrong. They don’t have a plan for significant or unexpected costs, and then something comes up. Funds which were reserved for income tax or GST are used, and then they are unable to meet their tax obligations and a significant problem arises.” 

Cash flow is king because it is often a business’s most important asset and without it, profitable firms can go bankrupt.  

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