In this section, I am going to share with you, everything that you need to know about having positive cash flow.
Let’s dive in.
What Is Positive Cash Flow?
When you have more money coming in than going out, your business has positive cash flow.
Pretty simple, right?
Well, sometimes you can have profit yet have negative cash flow.
Such a situation arises when you don’t have the cash you are owed some time in the future, but you continue to pay bills and expenses.
Take the case of a business, a marketing agency, that signed a contract worth $20k but didn’t receive payment until after completing the project.
The business received half the amount after delivering three-quarters of the work per the contract.
Before that, there was no money coming in, but the business was paying for sub-contractors, overhead expenses, and other costs directly related to the project.
However, if this marketing agency charged upfront for the project, they would have had a positive cash flow because it would have more money coming in than going out.
Why Is Positive Cash Flow Important?
It is important because positive cash flow means you have liquidity on hand if you need it. This liquidity can help you pay for sudden repairs to your office or hire people in case of sudden growth.
You can show investors and regulators that you are a responsible business owner with an investment-worthy business when you have a positive cash flow. Such a business will get better terms than one that is not cash flow positive.
How To Get Positive Cash Flow?
To do it, match cash outflow according to cash inflow. Set up a minimum cash flow balance to cover rainy days, be financially disciplined, and spend while staying above that minimum cash flow balance you set.
For example, instead of collecting the cash of £100k and spending £110k, which leaves you with a negative cash balance of £10k, set a target to have a positive £10k cash balance. Based on the £100k cash collection, only spend £90k and still have a positive £10k balance.
Do it by becoming disciplined and not spending an extra £20k in this period and spending in the next period, where you don’t have to pay other costs.
How Do You Determine Positive Cash Flow?
Go through your cash flow statement to determine if a company has positive cash flow. In a cash flow statement, you find how much cash your business collected in a specific period and how much cash the business paid in the same period. If the cash collected is more than the cash paid, the company has a positive cash flow.
Most entrepreneurs get confused with positive cash flow and profit. They say something like, “Why is my net income not equal to cash on hand?”
To answer this question, understand the difference between positive cash flow and profit.
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Positive Cash Flow vs. Profit
Generally, when the business is profitable, it also has positive cash flow.
Sometimes, a business can have positive cash flow and not be profitable OR have negative cash flow despite being profitable.
How is this possible?
Let’s look at an example of a positive cash flow business.
Business A – Positive Cash Flow and Profitable
This business has an opening bank balance of £10k.
The business collects £50k from clients in a month.
Then the business pays £30k to vendors.
Month-end closing balance = £10k+50k-30k = £30k, which means positive cash flow.
Business B – Positive Cash Flow but Not Profitable
This business also has an opening bank balance of £10k.
It collects only £10k, the same amount for sales from customers, and the owner puts £20k into the business.
The business also pays £30k to vendors.
Month-end closing balance = £10k+£10k+20k-£30 k= £10k, which is still cash flow positive.
But the problem is that this business is not profitable as revenue is less than costs and expenses. The only reason this business is surviving is that the owner is funding the business.
Business C – Negative Operating Cash Flow but Positive Net Income
Business C also has an opening bank balance of £10k.
The business collects only £10k from customers despite making sales of £50k in the month, and the owner does not put £20k into the business, like in business B.
Then the business needs to pay £30k to vendors, but the business has negative cash flow despite being profitable.
Why did the business only collect £10k from customers when sales were £50k?
Because the payments aren’t due yet.
So the business may be profitable and still have cash flow problems.
In this case, the month-end closing balance = £10k+10k-30k = – £10k (Negative cash flow)
If the term negative cash flow is new to you, I am explaining what it means below.
Negative Cash Flow
A business with negative cash flow means more money goes out than what comes in.
Again, this could be just like the example we used above.
Just because more money is going out than coming in doesn’t mean you are making a net loss. If you have to pay creditors before you collect the cash from clients, the business will have negative cash flow even though the business may be profitable.
So what could cause negative cash flow?
It can happen because of the following reasons.
I. Fraud or Theft
Unexplained spending could be due to an employee stealing from your business. Tony Robbins, who has coached everyone from Bill Clinton and Oprah Winfrey to Mother Teresa and Nelson Mandela, experienced this early in his career. While he was on the road doing seminars and making money for the business, a trusted employee was siphoning off the money by forging his signature. He only came to know of it later, when more than half a million dollars was gone from his business.
Prevent fraud and theft by working with external auditors, installing security cameras, separating duties, investing in inventory tracking systems, spending, and access to data.
II. Overpaying Vendors
To avoid overpaying vendors, establish a monthly supplier payment run process where at least two people are involved in cross-checking and approving the payments.
III. Large Cash Outflows
This could be due to spending a lot to cover equipment costs for a large project. It might be because you are expanding and need to buy or rent property around the nation or hire people worldwide. You may also be bidding for a project in the public sector and need to pay upfront before being awarded the contract.
IV. An Actual Loss
This may happen if you make a product far more than you can sell. You may find that you added a new product to your line and the marketing campaign costs more than you expected it to, and hence, it exploded your budget way beyond what you planned.
A prolonged negative cash flow can ring alarm bells with investors. They expect you to spend money and invest in the business, but they also wish to balance the books eventually.
Negative cash flow is part and parcel of new exciting businesses such as Tesla and Uber, but they are finally addressing their negative cash flow.
Your business doesn’t have deep pockets like them and needs to address it sooner. So watch out for profitability, stability, and sustainability, which you can have with constant positive cash flow.
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If you want to have financial stability in your business, you need to have a positive cash flow regularly. This section looked at positive and negative cash flow – what it means for your business and the difference between positive cash flow vs. profit.