Cash flow is the lifeblood of your business. Most simply defined, it’s the net amount of cash coming into and going out of your company. 

If you want to grow your business, you need to maintain a positive cash flow. Positive cash flow means you can pay your staff, access new opportunities, and make savvy financial decisions. The majority of small businesses fail due to cash flow problems.  

Our guide explores why cash flow is essential, the advantages of creating a cash flow forecast and how Xero can help you gain important visibility.

What’s the Difference Between Cash and Profit?

Cash and profit may, at first, appear similar. After all, they both have to do with the amount of money coming into your business.  The key difference between the two is primarily timing.

Profit or net income arises when you carry out the work or incur the expenses. Whereas, cash is when you receive the money from your customers and settle with your suppliers.

Increasing your revenue does not necessarily increase your cash flow as you might need to wait on payments depending on invoicing terms or recruit more staff to deliver the work.  In fact it is more likely that a business that is growing rapidly will run out of cash than at any other stage in the business lifecycle.

Why is Cash Flow Important?

There’s some debate amongst professionals about what’s more important, cash flow or profit. As the saying goes turnover’s vanity, profit’s sanity and cash is reality.  Both are important, without generating a profit a business won’t be sustainable in the long term however, with turning the profits into cash in the bank a business won’t survive.  

A positive cashflow allows you to operate your business, pay suppliers and avoid getting into debt. Positive cash flow means your company can run smoothly and even make new investments or expand into new markets.  It also allows you to sleep easy at night.

Investors and business analysts use cash flow to determine a company’s potential as it reveals whether a business can support itself and potential growth. It’s also almost impossible to manipulate over the long term (although Enron and Lehman Brothers amongst others have managed to do it in the short term by borrowing money through off balance sheet entities but that’s another story), so it is often considered a reliable way to measure a company’s current and future success. 

Failing to maintain a positive cash flow could also impact your company’s credit rating and reputation — making it harder to secure a loan or attract investors.

What is Cash Flow Forecast?

A cash flow forecast uses your current cash position together with your forecast trading and balance sheet position to predict your future cash position, so you can plan ahead and preempt any problematic periods. It takes things into account like overall sales, operational costs, payments to lenders and cash from other sources like bank loans. 

There are several distinct advantages to creating a cash flow forecast:

  1. Predict your business’ future. A cash flow forecast gives you a reliable way to plan future income and expenses and uncover any upcoming problems and avoid pitfalls.
  2. Understand possible outcomes. With cash flow modelling, you can examine different sceanrios and how various situations will impact your cash flow. For example, what happens if you don’t receive an important payment? What will the imapct be if you invest in a new market? Once you know the impacts, you can create a plan B and even a plan C. So, you’re prepared for all eventualities. 
  3. Track late payments. Small businesses spend an average of 130 hours each year, chasing late invoices. Cash flow forecasting gives you insights into frequent late payers, how it impacts your bottom line and helps you preempt these situations.
  4. Manage extra cash. Knowing when you might have extra cash, like after the busy Christmas season, means you can set up opportunities for further growth like investing in new markets or repaying bank loans.
  5. Monitor resources. If you know when you’ll have cash gaps or increased demand, you can plan ahead and manage resources accordingly. Perhaps you only take on short-term temporary staff to cover busy periods, rather than investing in permanent staff. Or, maybe you need to cut back on expenses during specific months to survive periods of negative cash flow. With a cash flow forecast, you can plan and budget accordingly. 
  6. Increase investor & stakeholder trust. Providing stakeholders and investors with detailed cash flow forecasting can increase trust and help them understand what the future of your business looks like. Building these relationships will allow you to ask for additional investments and financial support if needed, or reassure them their investments in good hands.

How to Calculate Cash Flow Statement on Xero

Thankfully, Xero makes it easy to generate an historic cash flow and get detailed reports. Below, you’ll find a step-by-step guide on how to run a cash flow report.

  1. Go to the Accounting menu and select reports
  2. Click Financial>Statement of Cash Flows – Direct Method (New)
  3. Select a date rate. 
  4. Click Report Settings to narrow in on specific details like comparing periods (we typically suggest 13 months), tax, or report tracking
  5. Click Update

You’ll now have a detailed historic cash flow report.

How to Prepare a Short-Term Cash Flow Forecast on Xero

One of the things that we love about Xero is that they’re continually improving their functionalities and features. They’re currently piloting an exciting short-term cash flow feature.

The short-term cash flow feature makes creating a cash flow report even easier. So, you can look at your company’s immediate needs and predict cash flow for the next week or month.   It gives you important insights into looming bills, incoming invoices, and when you can expect payments. For longer forecasts we use dedicated cash flow apps connected to Xero to provide up to date information.

Short-Term cash flow forecasts give you insights into what invoices you need to follow up or if you need to cut back on expenses immediately. 

You can find more details about the pilot and register your interest at Xero.

Leverage Xero Insights with Empowered by Cloud

Here at Empowered by Cloud, we specialise in helping businesses make the most of their Xero accounting software. As Xero consultants, we’ll work with you to create efficient financial systems and uncover valuable financial insights. With us by your side, you’ll have a better understanding of your business and financial future.

Contact us to learn more about our services and how we empower small businesses like yours.