In this guide, I will share comprehensive information on cash flow drivers that affect your cash flow. From my experience as a Chartered Certified Accountant, I have worked with small businesses in various UK industries for the last twenty years. These are the key drivers I use to improve cash flow.
Whether you sell a physical product or provide a service, these cash flow drivers will help you manage cash flow and improve cash flow.
By pulling cash flow drivers, you can maintain liquidity and increase your business valuation as your company generates consistent positive cash flow. This is a good business sign for investors.
When you know these levers, you can make strategic business decisions that will pay you dividends for the future.
I am going to cover these areas:
Ten important cash flow drivers that affect your company’s cash flow
How does cash flow affect the financial health of the business?
Three Common questions business owners ask me regarding how cash flow affects their financial health and decision-making regarding working capital in particular.
Let’s dive in.
Key Takeaways
Understanding Cash Flow Drivers: Mastering ten critical levers—sales price and volume, direct costs, overheads, debtor and creditor management, taxes, inventory, capex, and dividends—is crucial for enhancing cash flow in small businesses.
Strategic Management for Growth: Employing strategies to improve sales, manage costs, and efficiently handle receivables and payables can significantly boost cash flow, ensuring operational stability and attracting potential investors.
Financial Health and Decision Making: Effective cash flow management is vital for maintaining financial health, enabling businesses to invest in growth opportunities and navigate through economic challenges confidently.
What Are Cash Flow Drivers?
Cash flow drivers are the financial drivers that impact cash flow.
Here is the list of ten levers.
Price – Sales price
Volume – Number of transactions in a specific period
Direct Costs – The cost of goods sold or cost of services-
Overheads – Overhead expenses to pay
Debtor – Cash to be collected from the Customer
Payables – Cash payments due to creditors
Taxes – Taxes to pay when they are due
Inventory – Stock to sell
Capex- Capital Expenditure
Dividend payments to shareholder
Let’s learn about each of these in detail and start by talking about how sales
1. (Sales) Price: How Do Sales Affect Cash Flow?
The sales price is one of two levers related to sales that affect cash flow.
Another lever is sales volume. I’ll talk about that in a bit.
If sales volume stays the same, higher prices raise cash flow. Lower prices reduce it.
2. (Sales) Volume: How Does Change in the Number of Transactions Affect Cash Flow?
When you can’t change sales price and want to increase cash flow, you can increase it by increasing sales volume.
If the sales price remains the same and there is a decrease in sales volume, cash flow will decrease.
Let’s see what happens to cash flow when sales price and volume change.
So, an increase in the sales price and increase in sales volume = an increase in cash flow
A decrease in the sales price and a decrease in sales volume = a decrease in cash flow.
Prices may rise and sales may fall or vice versa. Or, prices may fall and sales may rise. In these cases, cash flow may rise or fall depending on the size of the price change and sales drop.
For example, company A LTD sells 100 units for £10, resulting in a £1,000 cash inflow.
If it increases units by 10, it becomes 110 units, which at £10 each equals £1,100 cash inflow.
If it increases the price, instead of units by 10%, then 100 units * £11= £1,100 as well.
On the other hand, if company A LTD sells 90 units instead of 100 units or drops the price to £90 instead of £100, then the figures will look like this:
90 units * £100/unit = £900
Or
100 units * £90/unit = £900 as well.
If both variables drop, then it can look something like this:
£90 * £90/unit= £8,100
Now, let’s discuss the next lever that affects cash flow.
When both sales price and sales volume increase, it means revenue growth. As revenue grows, it has an impact on cash flow.
If you want to go deeper into this area, check out how revenue affects cash flow
3. Cost: COGS (Cost of Goods Sold)
Costs of goods sold It is also known as variable cost. Because it varies depending on your sales activities.
When you sell a product, you make a promise to deliver or fulfil what you sold.
A business selling physical products usually builds them by getting raw materials from a supplier or getting someone else to build them.
If you are a coach or consultant selling your time, you either buy someone’s time and expertise to sell. Or, you use your own time and expertise to sell. When you pay for all these, it affects your cash flow.
I look at the gross margin as one of the key drivers for cash flow.
Gross Margin- Is the difference between how much revenue you make minus how much it costs you to deliver your customer. i.e Gross Margin= Revenue- COGS
If you want to go deeper into this area, check out how the cost of goods sold affects cash flow
4. Overhead Operating Expenses
Overhead operating expenses are also known as operating costs. These are expenses you pay whether you make a sale or not, just to open the door for your business.
Common overheads are administrative expenses like rent, payroll, subscriptions, professional fees, marketing costs, travel, and office supplies.
All these overheads affect your cash flow.
Take, for example, rent.
One of my clients runs a marketing agency based in Hammersmith. They work with tech companies to build their go-to-market campaigns. They pay rent of £2,275 net of VAT on a monthly basis. It is a fixed cost which is needed to run the business operations.
They have to pay for this regardless of whether they make sales or not.
Here’s the simple equation that shows how cash inflow, cash outflow, cost and overheads affect remaining cash:
Cash Inflow – Cash Outflow (COGS) – Cash Outflow (Overheads) = Operating Margin Cash Flow
One thing to notice is that operating margin cash flow affects profit and is the key driver of working capital.
This is because money used in different business areas is mostly from cash generated from operations. Not many businesses have the luxury of external funding like debt or equity.
Which means that.
If you want to ensure you have enough working capital to run your business operations, you must maintain your business’s profitability.
5. Accounts Receivable
Accounts Receivable is also known as debtor. These are the customers who owe you money.
You can easily see the accurate aged debtor’s financial transaction report if your bookkeeping is done properly. You can also see the balance in the balance sheet under the current asset section.
The more cash is tied up in receivables, the less cash you will have in your bank account.
If you have good credit control in place, you can collect the cash from customers on time. Timely cash collection based on payment terms positively affects your cash flow.
When reviewing debtor accounts, pay attention to the following:
1. invoicing cycle- Is it weekly, monthly? The quicker you invoice, the quicker you get paid.
2. accounts receivable days- How long does it take on average to get paid by the customer? If you reduce the number of days, then you get paid much quicker
For both of them, we, as accountants, refer to reducing the cash conversion cycle.
If you want to go deeper on this topic, I encourage you to check out how accounts receivable affect cash flow. It includes examples and strategies, like using invoices to factor in, to improve your cash flow.
6. Accounts Payable
Accounts payable is known as creditor. These are vendors you owe money to.
You can find the total creditor balance in the balance sheet under current liabilities. If you want a detailed breakdown, you need to access the aged creditors report.
Unlike accounts receivable, when cash is tied up in payables, it will positively affect your cash flow as you hold the cash.
If you make the payments by the due date, that’s fine. However, if you are holding on to it longer to keep cash in the business, it is unsuitable for a relationship with your creditors.
Pay attention to accounts payable days. This shows how long, on average, you are paying suppliers.
If you want to master this section that affects cash flow, check out the deep dive article on how accounts payable affect cash flow.
7. Taxes
In the UK, you have to pay four main types of taxes as a business owner.
Corporation tax
Tax payment you pay based on the profit you keep. Medium-sized businesses have to make quarterly payments. But, as a small business owner, your corporation tax payment is due nine months and one day after your company’s year-end.
Value Added Tax (VAT)
You pay VAT normally seven days after the quarter ends. There are so many schemes which trigger different payment dates. I am just sharing the most common one with you.
PAYE/NI
Paye and national insurance contributions you pay by the 22nd of the following payroll month.
Pension
If your employees have opted for workplace pensions, then pension contributions need to be paid to pension providers.
When you pay for these taxes, your cash flow goes down. You can go deeper in this area by following the guide- how taxes affect cash flow
8. Inventory
This is relevant for product-based organizations.
When you buy inventory, cash goes out, affecting cash flow. When you sell inventory, you collect cash, and cash flow increases.
In this case, you need to be paying attention to inventory days. How long does it take to make or own the inventory? Then, how does it take to get it sold and collect the cash?
If you want to understand this better, check out my masterclass with Zoho. I explain how inventory affects a business’s cash flow and financial health in this masterclass.
Now that you know what affects cash flow in a business, I’d like to share something important that all business owners don’t know.
Wondering what that important thing is?
That – cash flow can go down even when sales are up?
Yes, cash can fall when sales rise. This can happen because COGS and Overheads together may exceed sales. Or, it can happen when cash is tied up in debtors or inventory.
If your business is doing well but doesn’t have enough cash, look out for these ten levers to see which ones are hurting your cash flow.
Use your understanding of these cash flow levers to drive your cash flow positively.
I have covered this topic in depth in this guide. Check out how inventory affects cash flow and how to prevent inventory from consuming cash flow.
9. Capital Expenditure (capex)
As your business grows, you need to invest in more capital items. These include office equipment, desks, chairs, tables, and motor vehicles.
Or you might want to refurbish your freehold premises where your business runs. Just like one of the dental practice clients invested in refurbishing to make the clinic look meticulous.
So, your cash flow will decrease when you invest cash in capex.
Check out how capex affects cash flow guide to go into more detail.
10. Dividend payment to Shareholders
As a business owner, you get rewarded for the risk you have taken to go into business.
The reward comes in the form of a dividend payment.
You cash balance will fall when you get paid dividends. It will also fall if you withdraw cash from the business for personal reasons.
If cash drawdown is your concern right now, I advise you to check out- How Dividends affect cash flow and what to do about it.
Now that we have looked at the ten cash flow levers, we need to look into how to use these levers to increase cash flow.
How do you use cash flow levers to increase cash flow?
Here’s what you should do to use cash flow levers to increase cash flow.
Increase sales price and volume without increasing overheads and not material costs of goods and services.
Keep COGS (cost of goods sold) at least in line with sales margin and, even better, reduce slightly to improve margin.
Operate the business lean and mean, allowing for increased revenue without increasing overhead expenses.
Keep your receivables as low as possible. Create an internal system and process for sending invoices on time. Then, follow up to ensure payment is collected on time.
Take care of payables just in time. If you are given net 30 terms, you don’t have to pay the supplier immediately.
In the case of Taxes, always pay on time. The government provides various facilities for people who are having financial difficulty. Be aware of your options; if you are unsure, speak to your tax advisor.
Keep the balance between buying and selling the inventory and ensure a lot of cash is not tied up in inventory.
Your business will have positive cash flow by working on these areas that drive cash flow.
Now you clearly understand what affects cash flow, it is time to understand how cash flow affects business.
How Can Cash Flow Affect a Business?
To run a business, you invest in sales, marketing, and operations and need cash.
So, a business may be doing well and making sales, but it is in trouble if it doesn’t have the cash to pay the bills. Without cash, a business does not move forward, stagnates, and dies.
Data also tells us that cash flow affects a business’s health. According to Score.org, 82% of businesses fail because of cash flow problems.
Let me address a big question that my new clients often ask me.
How Do You Tell if a Company Is Financially Healthy?
Alongside, other questions like:
What is a healthy company?
How much cash flow is good?
What is a good cash flow percentage?
What are some good cash flow habits?
What is a healthy cash flow?
Is having a high cash balance good?
And, how much cash flow should my business have?
If you have some similar questions in mind, all of these will be answered by what I am sharing below.
First things first. The financial health of your business depends on its ability to generate profit and transform profit into cash flow.
To help you understand this better, I have listed three questions below and my response to each of these.
What Cash Flow Questions Do Growth-Focused Business Owners Often Ask Me?
1. Why Do I Have Sales Coming In, and There’s Hardly Any Profit at the Month-End?
It happens because of the low profit percentage. Which, in turn, depends on how you price your products or services.
A business with less than 15% profit left is unhealthy as there is no room to invest and grow the business. In addition, less profit margin means less cash flow balance in the bank account. In such a situation, if there are any unexpected, unforeseen costs to pay, then the business can’t afford it.
So this answers the question: What is a healthy cash flow ratio or a good cash flow percentage?
2. How Much Cash Do I Need To Survive in Business, Even When My Business Is Doing Well?
Ideally, you want to be covered for the next two quarters to pay your bill at all times.
At the least, you want the cash to cover the next quarter in case you don’t make any sales or don’t get new cash coming in. It’s called having a cash flow cushion in place.
Most businesses do not have the cash flow cushion and, as a result, go bust when there’s an economic downturn, sector-specific challenges, or any other crisis.
So if you are wondering – How much cash flow should my business have? Then, figure out how much cash flow cushion you need to survive in your business in any challenging situation, and keep that money aside. Then, invest the rest to grow your business.
3. What Do I Do When I Have Limited Cash Flow To Invest in Sales and Marketing, and There’s a Sales Dip?
If the business has a limited cash flow to invest in the areas that need attention instead of having high cash flow, then the business is not healthy. It’s like a body gasping for oxygen or a vehicle without fuel.
Even when the sales dip results in less cash coming in, the business is doing fine as long as the cash outflow is in proportion to cash inflow.
So, suppose you are financially disciplined to run your business, installing good cash flow habits to ensure to keep the cash flow margin intact. In that case, you have a financially healthy company.
Now you know how cash flow affects your business and its financial health.
Summary
In this guide, we looked at what affects cash flow and how cash flow affects business.
We looked in detail at the ten variables affecting cash flow and some common questions around this topic. Think of each lever as a tool to use to improve cash flow.
Every business has to go through a cash flow rollercoaster at some point in its business journey. By knowing the root cause of what’s affecting your cash flow, you can fix cash flow problems.
