Cashflow basics
This Cashflow basics Info Guide will help improve your understanding of the cashflow cycle, your sources of cash and your cash payments.
Cash is the actual money that flows:
- into your business when your customers pay you.
- out of your business bank account when you pay expenses, including staff wages, and other outgoings such as loan repayments.
Cash is concerned with the timing of the cash received (not what is promised!) and the timing of the cash paid out, including VAT, from all your transactions.
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Cash arises from trading transactions and non-trading transactions.
Cash typically comes into your business from these three sources:
1. Customers
2. Investors
3. Lenders
You have an advantage over many other businesses in that you receive payments from customers either on arrival or check-out, or shortly afterwards via credit card transactions.
But you still risk going out of business if you are not receiving the money due from your customers. You need to put controls in place to:
- ensure that customers don’t leave without paying.
- follow up with credit card companies or accounts that you give credit to.
Most businesses need start-up funds and often require an injection of cash as they develop. The first investor is usually you, followed by your family and friends. When these sources are exhausted you may need to find an external investor in order to further develop your business.
Lenders such as banks may provide a bank overdraft to get you through tough times in the short-term. If you are investing in assets, such as new equipment or a property extension, you may be able to secure longer-term finance such as leases, term loans and mortgages.
It’s more difficult to secure this type of funding during an economic downturn and you will need to satisfy your bank manager’s two major concerns, security and ability to repay.
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It’s essential that you learn to balance the needs of each payee and the timing of your payments.
The typical hostel, caravan park or self-catering business pays:
Depending on the size of your business, you may employ staff to clean rooms and/or to carry out repairs.
Remember!
You need to pay yourself as well as your staff either by salary or by drawings if self-employed; surprisingly this is often overlooked by business people when preparing Cashflow Forecasts!
Payment terms
- Agree payment terms with suppliers – negotiate the best deal and stick with it.
- Depending on your situation, you may have some flexibility with regard to payment method or payment timings.
Lenders usually make the rules of the deal and will tell you when you need to pay them. They are in a stronger position than other suppliers as they often have security over an asset, or a personal guarantee from you.
Remember!
Missing agreed payments to lenders can negatively impact your credit rating and your ability to borrow in the future.
- Many businesses have gone out of business as a result of unpaid taxes!
- Difficulties often arise because taxes are payable one month or more after you have taken in cash or paid your employee wages - the cash is gone by the time you need to make tax payments.
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Cash flows in and out of your business over a period of time. Cash flows in, for example, when you receive money from customers. Cash flows out, for example, when you make payments to your suppliers, pay electricity bills and pay staff wages.
The cashflow cycle
Cashflow can be described as a cycle: your business uses cash to pay suppliers, staff, lenders and Revenue. You provide accommodation and other services to your customers from whom you collect cash and you then use cash to pay suppliers, staff, lenders and Revenue. In this way the cashflow cycle is repeated again and again – cash in, cash out, cash in, cash out….
This continuously repeated cycle of cash inflows and cash outflows determines your ability to have enough funds to pay all your overheads and keep your business running.
Monitor your cashflow
In an ideal world, you would always collect more money than you pay out during each cashflow cycle. But in reality you need to carefully monitor your cashflow so that you can take action on those occasions when less money flows into your business than flows out.
Many business people fail to recognise that cash is the lifeblood of their business. They don’t realistically forecast their future cash inflows and outflows, and as a result they can’t anticipate when future cash shortfalls may occur.
Remember!
Your employees, suppliers, lenders and Revenue expect their payments when they fall due. Preparing a simple Cashflow Forecast helps you to know when cash is expected to flow in and out of your business. You can then identify when cash shortfalls may occur and carefully plan all due payments.
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Making a profit does not necessarily mean money in the bank! To fully understand cashflow, you need to understand these three key differences between profit and cashflow:
1. Activity
2. Timing
3. Non-cash items
Remember!
If you are VAT-registered, profit is calculated excluding VAT from transactions while cashflow includes VAT in receipts and payments.
Remember!
Depreciation is the amount that the value of equipment or other assets reduces by in the year – calculated as a percentage of their original purchase price.
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