There is an incoming and outgoing of cash in every business, regardless of the size. This flow of money is documented via a cash flow statement and has the potential to either make or break the company. A business needs to identify the crucial influencers of the cash flow and utilize them to their advantage so that the business can grow and expand. These influencers are also known as ‘cash drivers’.
First, let us understand the concept of cash flow and how is it essential for a business.
What is Cash Flow?
Cash flow is the movement of money in and out of your business. If the inflow of cash is more than the outflow, then you have a “positive cash flow” which is a good situation for any company. Similarly, if the outflow of money is more than the inflow, then you have a shortage of funds, and the business faces the hazard of having less liquidity in hand. All the transactions about any movement of cash utilisation in a cash flow statement. This statement is prepared every month and is very important to know the financial health of the company and to make the strategies for the future. The advantages of cash flow forecast are as follows:
- The analysis of cash flow helps you in understanding the company from a financial standpoint
- It will help you in the planning of future projects of the business
- Cash flows provide better Key Performance Indicators (KPI)’s
- Help in the better utilization of the present resources
The understanding of the importance of cash flows, by you, is a step towards the development and growth of your business. The next step would be to comprehend the essential drivers of the cash flow and how they affect the company.
Important Drivers of Cash Flow
There are some key cash drivers, understanding of which would not only help you in the proper utilisation of your resources but will also assist you in planning the future of the business. The appropriate knowledge and awareness of these influencers can help the company realise its full potential. These key drivers are:
1.Accounts Receivable Days
It is also known as Debtor day ratio and can be defined as the average number of days that a customer takes to pay the credit given. The customers do not always pay back the amount in the stipulated time, so the account receivable days can be lengthier than anticipated. This time gap between the creation of a bill and its full payment can profoundly influence the cash flow of the business which would, in turn, affect the growth of the business.
2.Accounts Payable Days
IT is the average number of days that a company takes to pay its suppliers or vendors. Also known as Creditor day ratio, it indicates the financial efficiency of your business. Usually, a business pays its vendors in a faster manner, especially in comparison to the accounts receivable. If the amount received in the month is less than the amount to be paid, it will create a situation of a shortfall for the business.
3.Work in Progress
Work in progress is also known as Stock day ratio and is the average number of days a particular company to convert all its inventory into a product which is sold. It can also be denoted by the average number of days that a specific product sits in the stock before being sold off. Proper utilisation of the resources would decrease the amount of work in progress days and would positively impact the cash flow of a business.
This includes any change in rate or any temporary discount. Your company must be able to predict all the changes in the future and create a plan according to it. This can be done by understanding the price margins and the effect of the business environment on these margins. If the profit margins are decreasing, then it is essential to assess the margins and what prices need to be kept.
The notion of increasing sales to increase the cash flow is not correct. A hike in the transactions can sometimes worsen our cash flow problems. As we know that the customer usually does not pay the company right away, so a company needs to have enough money to cover their labour costs and daily operating expenses. In such a case, boosting our sales can be a very wrong approach to affect the cash flow.
6.Cost of Goods Sold
The Cost of Goods Sold is the cost incurred by a company which is directly linked the production or the delivery of a service. If somehow the COGS is reduced it would directly affect the cash flow of the company. This can be done by various methods such as buying materials in bulk, negotiating with suppliers, etc. Even a slight reduction of COGS can cause noteworthy deviations in the bottom line of your company.
Overhead costs are the expenses that happen frequently. It includes your rent, internet services, light, power, payroll, etc. Any changes in the overhead costs would significantly affect the cash flow of the business. This can be done by keeping track of the budget and monitoring any discrepancies in it.
These are some of the significant cash drivers for any business, and their understanding would significantly affect the cash flow of a business. If you want to manage the cash of a company successfully, then you need to monitor the various components of the working capital cycle continually.
We at JAXA aim to provide all possible help by giving some of Cash Flow and Forecasting services consisting of Daily cash-flow report, Cash flow budgeting, Managing electronic payments, Financial risk management, etc. In case of any query, please contact us, we’d be glad to assist.