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Tax & Assurance Guidance

Understanding Your Cash Flow is Important-Here’s Why

Posted on June 24, 2022 by

Dave Van Damme

Dave Van Damme

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Managing cash flow in a business should go far beyond ensuring that you have funds available to pay your current bills. While that’s a threshold every new business should meet, developing deeper cash flow management skills is necessary to scale your business and prevent unnecessary stress.

Inflows and Outflows 

Understanding how, when, and where your business is receiving and spending its money is the first critical step in cash flow management.  

Dave VanDamme - Cash Flow

If you are reviewing a Statement of Cash Flows as part of your financial statement package, you are off to a great start. If you aren’t doing so yet, the cash flows statement separates cash transactions and balances into operating, financing, and investing activities. This allows owners and others to gauge whether funds are being utilized as intended and are available for upcoming needs – – basically breaking down the financial results into a cash-basis analysis.  

Drilling down on cash-impacted accounts and categories such as accounts receivable (AR), accounts payable (AP), cost of goods sold (such as inventory), investments in capital, debt repayments and others provides the insights necessary to make better business decisions. 

Short and Long-Term Considerations 

Short-term cash needs may feel more pressing but planning for the longer term is just as essential.  

When your current machinery is on its last legs, or attempting to adjust to the future demands of the workforce and replacing elements of the business with automation, you know it’s time to set aside funds or begin to secure financing for its replacement. Longer-term product or plant expansions also require achieving a high level of cash reserved (or borrowing) for the project and careful preparation to ensure a loan will be funded when the time comes.  

Understand Your Metrics & KPIs 

Financial metrics can come directly from your financial statements such as your gross margin, working capital, and your current ratio, but other KPI (Key Performance Indicators) may help your business in a more meaningful way. KPIs are derived by integrating other information, such operational cash flow and working capital measures, which provide context for the numbers and help drive better decision making.  

Some metrics, such as days sales outstanding (DSO), are immediately actionable and prompt attention to them can change your cash position. With DSO, the current AR balance is divided by total credit sales and multiplied by the days in a year (365). A lower number indicates that most of your receivables are collected promptly within the first month after invoicing. Higher DSOs indicate that you could have opportunities to secure payments more quickly, alter your payment terms with existing or new clients, require deposits for payments, or chase after non-payments, which will all ultimately strengthen your cash position.  

Similarly, if your AP review shows that you are paying invoices sooner than necessary, you may want to adjust your AP system to issue payments based upon necessity.  This allows you more flexibility and the opportunity to earn interest or invest your cash for longer periods. 

Tracking your Days Cash on Hand can help you decide if you have too little or too many funds on hand for your situation. Industry standards can help guide you in understanding if you should be investing more funds into your business or if your cash position is right on point.  

Lenders and Investors 

Business opportunities often take months to nurture but sometimes they occur out of the blue. Many of us are accustomed to opening and managing accounts online, but when a line of credit or construction loan is needed—particularly on short notice—it’s ideal to have an in-person relationship already established with a banker. 

Lines of credit are extremely helpful to business owners when funds are needed for short periods of time, such as for purchasing goods or materials to services a client who will pay you within a short time of receiving your products. Their purchase order can help secure a short-term loan when it’s accompanied by your financial statements and solid credit rating.  

Equipment draw-to-lines and longer-term financing, such as term loans, are also an option when reviewing and evaluating the future needs of businesses. Lenders will often look for and at security positions in the tangible assets and want to assess the company’s ability to generate future cash flows to repay borrowed amounts. 

Developing Confidence with Cash Flows 

Business owners and managers who have a firm grasp on their cash position can make informed decisions about how and where to invest their profits to grow their business. Conversely, owners will be swimming uphill if the business hasn’t put together a forecast that shows the future needs of the business and related ability to repay amounts borrowed through future cash flows, as lenders are looking for a company’s best use of the resources available to them.  

Continue the Conversation 

If your business might benefit by having your cash flows analyzed and receive guidance on potential opportunities for improvement, contact Clayton & McKervey today to leverage our knowledge and strengthen your cash position.  

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Dave Van Damme

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Leading the firm's advisory & assurance group, Dave supports closely held businesses with audits, financial reporting and fraud analysis.

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