Cashflow refers to the amount of cash a company receives versus the cash it spends. When there is more cash coming in than is going in, that is known as a positive cash flow. The reverse is called negative cash flow. Cash flow changes are driven by money going into or coming from operations, finance and investment.
Positive cash flow in the medium to long term is viewed as a sign of a healthy business. That said, profitable businesses may experience short windows of negative cash flow. Companies with negative cash flow over a long period eventually eventually become insolvent and may have to declare bankruptcy.
Cash flow challenges could occur for multiple reasons including:
- Rapid business growth.
- Shifts in consumer demand.
- Loss of a major customer.
- Client failing to pay a large invoice within the agreed time.
- Changes in price of raw materials or stock.
- Entry of cheaper alternatives in the market.
- Downturn in market conditions.
Lenders will often look at the cash flow to determine the amount of cash they should give a business. The cash flow is found in the statement of changes to financial position. To calculate cash flow, you find the earnings before deducting interest, taxes, depreciation and amortization (EBITDA) and deduct contractual debt payments of interest and principal to find the net cash flow.
Businesses can improve cash flow by:
- Improving the process of debt collection.
- Agree on payment terms in advance.
- Increase your credit facilities including overdrafts, loans and other forms of debt finance.
- Rent instead of buying vehicles, machinery, furniture, computers and other assets.