In this section, I am going to share with you a complete guide on what affects cash flow and how cash flow affects business financial health.
If you want to get a handle on cash flow in your business, so that you have cash flow clarity and control, you need to read this.
- I am going to cover these areas:
- Eight levers that affect 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.
Let’s dive in.
What Affects Cash Flow
Here is the list of eight levers that affect cash flow.
- Price – Sales price
- Volume – Number of transactions in a specific period
- Cost – The cost of goods sold
- Overheads – Overhead expenses to pay
- Receivables – Cash to be collected from sales
- Payables – Cash payments due to creditors
- Taxes – Taxes to pay when they are due
- Inventory – Stock to sell
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.
Assuming there is no change in sales volume, an increase in sales price will increase cash flow, and a decrease in sales price will decrease cash flow.
Now let’s see how a change in sales volume and sales price affects cash flow.
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.
Now, 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
Decrease in the sales price and decrease in sales volume = decrease in cash flow
When there is an increase in the sales price and decrease in sales volume or vice versa OR a decrease in the sales price and increase in sales volume – there can be an increase or decrease in cash flow depending on how much the increase in price and decrease in volume.
For example, company A LTD sells 100 units for £10 which results in £1000 cash inflow.
If it increases units by 10, then 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
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.
3. Cost: COGS (Cost of Goods Sold)
When you sell a product, you make a promise to deliver or fulfill what you sold.
A business selling physical products usually builds them by getting raw material 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 use your own time and expertise to sell. When you pay for all these, it affects your cash flow.
These are expenses you pay whether you make a sale or not, just to open the door for your business. Common overheads are rent, payroll, subscriptions, professional fees, marketing costs, travel, and office supplies.
All these overheads affect your cash flow.
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) = Remaining Cash Flow
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 on time. Timely cash collection has a positive effect on your cash flow.
When cash is tied up in payables, it will positively affect your cash flow as you are holding the cash.
If you are making 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 not suitable for a relationship with your creditors.
You have to pay various taxes such as corporate tax, sales tax, social security tax, income tax, etc. So when you pay for these taxes, your cash flow goes down.
When you buy inventory, cash goes out, and it affects cash flow. When you sell inventory, you collect cash, and cash flow increases.
If you want to understand this better, check out my masterclass with Zoho. In this masterclass, I explain how inventory affects a business’s cash flow and financial health.
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, it’s possible for cash to go down even when sales are up, because COGS and Overheads combined may exceed sales or when cash is tied up in debtors or inventory.
If your business is doing well but you don’t have enough cash, then look out for these 8 levers to see which ones are hurting your cash flow.
Use your understanding of these cash flow levers to drive your cash flow in a positive direction.
How to use cash flow levers to increase cash flow?
I have shared pointers below on how you can use each of the levers I shared above to increase cash flow.
- Increase sales price and sales 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 to increase revenue without increasing overhead expenses.
- Keep your receivables as low as possible. Have an internal system and process to send the 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, then don’t have to pay the supplier immediately.
In the case of Taxes, always pay on time. The government allows various facilities for times when you are in financial difficulty. Be aware of your options and if not sure, speak to your tax advisor.
- Keep the balance between buying and selling the inventory and make sure a lot of cash is not tied up in inventory.
By working on these areas that drive cash flow, you will have positive cash flow in your business.
Now you have a clear understanding of what affects cash flow, time to understand how cash flow affects business.
How Can Cash Flow Affect a Business?
You invest in sales, marketing, and operations to run a business. To do this, you need cash. So a business may be doing well, making sales, but if the business doesn’t have the cash to pay the bills, it is in trouble. Because without cash, a business does not move forward, stagnates, and dies.
Data also tells us cash flow affects the health of the business because as per 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.
Find Out Tough to Gather Insights in Minutes
With Our Cash Flow Calculator
Three Common Questions Business Owners Ask Me Regarding How Cash Flow Affects Their Financial Health.
Question 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 product 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 what is a good cash flow percentage?
Question 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.
Question 3. What Do I Do When I Have Limited Cash Flow To Invest in Sales and Marketing and There’s a Sales Dip?
Instead of having high cash flow, if the business has a limited cash flow to invest in the areas that need attention, 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, as long as the cash outflow is in proportion to cash inflow, the business is doing fine.
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 the financial health of the business.
Find Out Tough to Gather Insights in Minutes
With Our Cash Flow Calculator
In this section, we looked at what affects cash flow and how cash flow affects business.
We looked in detail at the eight variables that affect cash flow and some common cash flow questions around this topic. 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 will be able to fix cash flow problems.