Managing Cash Flow Guide: Analysis, Tips & Tricks

Cash flow management involves monitoring and optimising cash inflows and outflows and maintaining an optimum cash position.

Suppose your company typically maintains £50,000 cash on hand for regular business activities.
One of your suppliers recently went bankrupt and wants to sell all of their inventory at half price. Unfortunately, if you use up all your cash, you might end up in a cash crunch.

Let’s say you’ve decided to prepare for future opportunities by improving your cash position. Assume that most opportunities that come your way require £25,000 to £50,000. However, you take an excessively conservative approach and decide to maintain £200,000 cash in hand.

That’s a problem too.

Any cash you hold over £100,000 is likely to sit idle and has an opportunity cost. This is cash you can invest in other areas of business—assets, marketable securities, or inventory—and generate a better return.

Here’s why cash flow management is mission-critical, especially for small and medium-sized businesses:
Remain cash flow positive: Your business should generate more cash than it uses, at least over longer time frames. Businesses that lose cash over the long term end up bankrupt.

• Maintain liquidity: You always want enough cash, but never too much. Aim to have enough cash to support daily operations and tap into opportunities—such as a limited-period deep discount on a bulk order from one of your suppliers. Small and medium businesses often lack visibility into their cash position and movement. This can lead to an unexpected cash crunch or ineffective use of cash.
• Financial management: If you’re about to face a cash crunch because of a slow season or high capital expenditure in the last quarter, cash flow management will flag this issue before it turns into a major problem for your business. This gives you enough time to raise capital or free up cash from other resources and address the problem at the source.
• Improve creditworthiness: Lenders and investors pay close attention to cash flows. Effective cash flow management practices improve your credibility, making it easier to access financing when you need it.

A cash flow statement categorises cash inflows and outflows into operating, investing, and financing activities. However, there are a few other cash flow types that add a new perspective to your analysis. Let’s dig deeper into each type below.

Operating activities

Cash inflows and outflows generated from your core business activities go here.

Cash coming in from sales and used towards operational expenses, including salaries, rent, and supplies, is included in cash flow from operating activities.

Investors and lenders look at cash flow from operations to assess your business’s financial health. It tells them if your business can sustain itself without needing outside financing or survive at all.

Over the long term, operations are the only sustainable way to generate cash for your business. Businesses that remain cash flow negative from operations for long generally end up in bankruptcy.

Investing activities

Cash flow generated or used in buying or selling assets, such as equipment, investments, and property goes here.

High-growth businesses are often cash flow negative because of their investing activities. They tend to invest heavily to fuel growth.

Suppose you sell pet grooming products online. Business is doing well, but you need to build a second warehouse to support revenue growth. You need £1 million in cash to buy property, racks, cooling systems, and inventory, while you only generated £200,000 in cash during the current year.

While all of these investments are expected to generate cash in future periods, they put a major dent in the current year’s cash flow tally. That’s where external financing comes in.

Financing activities

Cash received from or paid to external financing sources goes here.

Transactions in this category are heavily driven by growth, just like the previous category. However, their relationship with growth is inverse.

High-growth businesses raise capital from external sources (a cash inflow under financing activities) to invest in assets (a cash outflow under investing activities).

On the other hand, mature businesses might return capital by buying back stock (a cash outflow under financing activities).

If the business does well, they’ll be able to buy back stock through cash generated from operations. On the flip side, if the company fails to succeed, it may have to sell assets (a cash inflow under investing activities) to repay investors and lenders.

Other types of cash flows

While a cash flow statement only categorises inflows and outflows into operating, investing, and financing activities, analysts often calculate other cash flow metrics for deeper analysis.

Here are some examples:

• Free cash flows: Free cash flows are cash flows available (or “free”) for a specific purpose. Depending on the purpose, free cash flows are further categorised into the following:

• Free cash flow to the firm (FCFF): FCFF (also called “unlevered cash flow") is cash available to both equity and debt holders before any debt is repaid. Investors use FCFF, along with other variables, to value the company as a whole because it offers a view of cash flows independent of the company’s capital structure.

• Free cash flow to equity (FCFE): FCFE (also called “levered cash flow”) is the cash available to equity shareholders after accounting for all expenses, taxes, and debt payments. Equity investors use FCFE, along with other variables, to gauge the market value of their shares.

• Adjusted cash flows: Adjusted cash flows factor in the impact of expenses that are non-operational and one-off, such as restructuring costs or natural disasters. This helps stakeholders evaluate performance while removing the impact of expenses that skew the analysis and are unlikely to recur.

Suppose a company sells cosmetics. It was recently sued by a customer for using unsafe chemicals. The company paid £100,000 to settle the lawsuit. The settlement amount appears under operating activities in the statement of cash flows, turning cash flow from operating activities negative. However, it’s a one-off cash outflow that skews the company’s real cash-generating potential from operations. That’s where adjusted cash flows help.

There are several cash flow variables you need to keep a close eye on. We’ve divided the entire cash flow management process into three simple steps. Let’s zoom in on this process.

Calculate your cash outflow and inflow

The first step? Track your cash.

Look at where your business is using and receiving cash from. All the information you need for this step is available on your cash flow statement. However, cash flow statements can seem daunting, especially if you’re a new founder.

The reason? Because most companies choose to prepare cash flow statements using the indirect method. It’s easier to prepare but makes the statement appear more complex because it involves dealing with non-cash transactions and unrealised gains or losses.

The only difference between cash flow statements prepared using the direct versus indirect method is the way cash flow from operating activities is calculated.
If your company also uses the indirect method, be cognizant of the fact that it includes non-cash expenses like depreciation and amortisation and unrealized gains and losses such as held-for-sale assets.

Here’s how to calculate cash flow from operating activities when using the indirect method:

Cash Generated from Operating Activities = Net Income + Non-Cash Expenses + Changes in Working Capital

Let’s compare a hypothetical company’s cash flow statements, one prepared using the direct method and another using the indirect method, to look at the difference more closely.

Cash flow statement prepared using the indirect method:

Cash flow statement prepared using the direct method:

If you’re a small company, chances are you don’t prepare a cash flow statement at all. However, you can always invest in cash flow forecasting software to track and analyse cash flows.

Cash flow forecasting software can generate forecasts automatically based on financial data pulled from your financial software. Speaking of forecasts…

Create a comprehensive cash flow forecast

While there are several variables to consider, future growth estimates, cost structure, and payment terms are key drivers of cash flow forecasts.

Here’s a quick overview of how to forecast cash flows:

• Forecast cash flow from operations: Start with revenue. Subtract all operational expenses you expect to pay during a specific year.
• Forecast cash flow from investing activities: Forecast how much you’ll need to invest in assets to sustain or fuel growth over the forecast period. Some of these purchases will be financed through existing cash balance, cash from operations, and cash from sale of other assets.
• Forecast cash flow from financing activities: Forecast your cash needs. If you don’t have enough cash on hand to buy assets or run the business, you’ll need to find investors or lenders. If you expect to have excess cash over the next few years, you might also consider repaying debt or buying back shares. Factor these into your forecasts.

Remember: Choosing between debt and equity requires careful consideration. Aim to maintain a healthy debt-to-equity ratio, which differs among industries, but 2:1 is generally considered healthy. Raising debt can put pressure on future cash flows because of the interest expense, so it’s not an ideal decision if you’ve run out of cash because of poor business fundamentals. On the other hand, if business is doing well and you need cash for growth, debt is an excellent way to avoid equity dilution.

• Sum up the totals: Sum up the cash flow from all three categories to get the change in cash position during a given year and add it to the previous year’s cash balance to calculate the ending cash balance.

Monitor cash flow and report regularly

There’s almost always a deviation between forecasts and actual numbers. That’s why it’s important to monitor cash flow and adjust forecasts on a rolling basis to reflect evolving business circumstances.

The problem? Building cash flow forecast models manually is a time-intensive and error-prone process.

That’s where cash flow forecast software comes in. It helps automate all parts of the forecasting process and generates insightful reports that help you make data-backed decisions.

While software can help with general cash flow reports in real-time, the ideal reporting frequency is different for every business. Here’s some general guidance on frequency:

• Daily reporting makes sense for businesses with highly volatile cash flows, such as retailers and restaurants. This helps monitor real-time liquidity and identify cash shortages before they turn into a bigger problem.
• Weekly reporting is ideal for small to medium-sized businesses with moderately steady cash flow, such as professional services or eCommerce stores. Weekly cash flow reports help you spot trends without spending too much time on unnecessary details.
• Monthly tracking is best for large businesses with structured financial processes and fairly stable cash flow. The finance team can use data in cash flow reports to assess if the business is on track to hit its goals.

Let’s look at an example cash flow statement and draw some insights. Suppose Julia’s Jacket Junction (JJJ), an eCommerce business, reports the following cash flow statement for the year ending December 31, 2024:

A quick scan of the cash flow statement tells me this about JJJ’s cash flows:

• JJJ is generating cash from operations, which is a hallmark of a healthy business that’s sustainable over the long term.
• The amount of cash inflows and outflows shows JJJ is currently a small business in an industry (ecommerce) with ample room for growth.
• JJJ is investing a good amount of money back into the business, given that over 70% of the cash generated from operations was invested towards buying new assets.
• The company has also raised debt and equity capital, which indicates the company needs capital to fuel growth over the next few quarters.

This is a generic idea of how you can interpret and analyse your cash flows. The interpretation of the cash flow statement may be different for your business based on the industry, business environment, and maturity of your business.

Managing cash flows is vital to your business’s growth and long-term survival. Let’s look at three tips from experts that can help you manage cash more efficiently.

Create a financial budget and stick to it

A budget offers various benefits to a business, but most importantly, it acts as guardrails that help you manage financial risk. It gives you a general idea of how much cash you’ll need and the amount of cash you can generate from operations or raise through external financing sources.

It also helps you determine the ideal amount to spend on various parts of your business so you don’t end up overspending or underutilizing your cash resources. Striking a balance between these two requires taking calculated risks.

Let’s use JJJ as an example again. JJJ is a high-growth business that uses ads to generate leads for its eCommerce website. The company decides to spend £10,000 on ads next year to gain market share.
If JJJ spends more on ads, it might be able to generate more leads, sell more, and increase its cash inflow. To spend more, JJJ must reallocate some of its warehouse rent budget to ads and if the ads do yield good results, JJJ will have the cash to pay rent.

Unfortunately, deviating significantly from a budget like this is more of a gamble than a calculated risk. A slow quarter or poorly executed ad campaign can threaten JJJ’s existence, and that’s why it’s important to stick to your budget.

However, suppose you were able to sell an old asset during the year for a good price and decide to spend that on ads. This might be a calculated risk, provided you have a reasonable argument in favour of this decision.

Look at past payment performance to identify any trends

Past payment performance helps identify trends. Are there any vendors that you no longer have a relationship with because of multiple delayed payments? If there are, investigate the cause. Potential causes include:

• Cash flow crisis: If your business is bleeding cash, it likely won’t have any money to pay to vendors when their invoices become due.
• Seasonal patterns: Did you miss payment due dates because you ran out of cash during off season? This is an easy fix—just prepare a thorough budget.
• Rigid payment terms: If a vendor’s payment terms prove to be too rigid for you, consider renegotiating. If they offer an unmatchable deal, again, just prepare a thorough budget so you always have enough cash to pay on time.

At the same time, it’s also important to monitor customer payment performance to avoid cash flow problems, especially if you’re a B2B business that works with a handful of clients. Customers who don’t pay on time increase the need for working capital, which leaves you with less cash to invest towards growth.

Try to fix delayed payments from clients by offering early payment discounts, provided they make financial sense, and automate invoicing and collection reminders to prevent delays from your end.

Use cash flow forecasting software for accurate reporting

Most importantly, you need complete visibility over current and expected cash flows. Use cash flow forecasting software to build forecasts and derive the following insights:

• Future cash position: How much cash will you have in the bank in future periods? Ensure that your cash balance doesn’t dip below a certain level so you can take advantage of opportunities and ensure sufficient liquidity.
• Cash needs: Forecasts show how much cash you might need in future periods based on various factors, including estimated revenue, investment needs, and capital redemption obligations. If your forecast shows a cash shortfall during any period, prepare for it by determining the ideal way to raise more capital or free up capital by selling old fixed assets you no longer need or long-term investments.
• Cash flow composition: The majority of your cash inflows in the long term should ideally come from operations—you can’t keep selling assets or raising external capital forever. If you’re a young company, you’ll also have substantial cash coming in through external sources of finance.

Pro tip: Don’t factor in cash inflows from external sources of capital in your forecasts. There’s more to consider. You also need an optimal capital structure to minimise the cost of capital, comply with debt covenants if there are any, and ensure interest expense doesn’t put a big dent in your cash flow every year.

Reporting this information to stakeholders timely ensures you can prepare for a potential cash crunch and map a strategy to navigate cash-related challenges without a major adverse impact on operations.