Having supported thousands of UK SMEs, we know that managing cash flow will be one of your top priorities as a business owner.
Your awareness and control of what’s coming in and what’s going out can be crucial to your survival and success. But if you want to improve your cash flow and make your operations as sustainable as possible, it helps to have a clear understanding of your cash flow cycle.
To help you get to grips with this common business finance term, below we’ve broken down:
· What a cash flow cycle is
· Why your cash flow cycle can be so important
· How to understand your cash flow cycle
· Common issues businesses experience and how to resolve them
A cash flow cycle describes how cash flows in and out of your business. This involves looking at your expenses, debt, revenue and receivables to see how they fluctuate over time. If you can achieve the right balance in your cash flow cycle consistently, you’ll always have enough cash available to run your business smoothly.
Usually, money will flow through your business in a relatively predictable pattern. A typical cash flow cycle goes something like this:
· Your business spends money on equipment, stock, staff wages etc
· You use all this to produce a product or deliver a service
· You sell products or collect customer invoices at a later date
From this cash flow cycle example, you’ll see that cash goes out before it comes back in again. But the length of the period in between is often the most crucial stage of the cycle and can vary significantly from one business and industry to the next.
Cash flow is important for businesses in lots of different ways. Firstly, having an efficient cash flow cycle means you’ll have enough money available to cover regular expenses like wages and rent. You’ll have peace of mind knowing that even when cash is going out to fund your operations, you’ll have enough left over to keep the lights on until you get paid.
In contrast, with a more challenging cash flow cycle, you could be forced to delay wages or reduce staff numbers. In a worst-case scenario, you may have to shut down for good – even if you know you’re likely to have money coming in again a few months later.
But as well as aiding survival, maintaining a strong cash flow cycle can also give you the spending power you need to grow. You could want to keep cash aside for a wide range of purposes such as:
· Hiring new staff or paying for staff training
· Upgrading equipment or buying extra stock
· Improving your facilities or moving to a larger premises
· Investing in marketing to drive more sales
Having a clear and realistic knowledge of your business’ cash flow cycle can help you identify potential problems and plan ahead to avoid them. Below are the key elements your business could need to balance against each other at any one time.
Expenses include all your regular business costs, such as staff wages, rent and utility bills. This category also covers anything you buy from suppliers to create your product or deliver a service, like raw materials or software licensing fees.
Debt includes any promises your business makes to pay someone at a later date. Taking on debt can be useful in that delaying a payment will give your business extra cash to spend now, reducing short-term disruption to your cash flow. But bear in mind these arrangements usually come with repayments that add to your expenses, as well as extra costs in the form of interest.
Often referred to simply as sales, revenue is the income you generate from normal business operations such as selling goods or services. It also includes any non-operational income, like interest gained from investments.
Receivables are effectively promises of payment. Whilst receivables look fantastic on paper, they don’t translate into actual cash until the money is deposited into your account. To have an optimum cash flow cycle, it is important to get your receivables converted into payments as quickly and consistently as possible.
While most cash flow cycles are at least somewhat predictable, running a business often brings surprises.
Two common issues that can affect a business’ cash flow cycle are long payment terms and late payments. Payment terms can vary wildly by industry, ranging from full payment before completion to payment anywhere up to 90 days afterwards. Longer payment terms can put a strain your cash flow – while late payments only add to the problem further.
The results can be crippling for small businesses. It’s a reality recognised by the UK government’s reforms to the Prompt Payment Code, which are designed to make sure larger companies pay suppliers on time.
Another potential challenge to your cash flow cycle is unexpected dips in revenue. Your business may be seasonal and affected by bad weather or other events out of your control, such as major building works deterring customers. Generating less revenue than expected while expenses remain at the same level is bound to disrupt your cycle.
Then there are unexpected expenses. If you run a restaurant and an oven or fridge breaks down for example, the cost to repair or replace it could be significant. Your regular expenses can also go up if the cost of materials or stock suddenly increases, eating into your available cash.
There are various strategies and tactics you can use to improve your business’ cash flow, including those we’ve explained below.
Shorten your cash flow cycle
As we’ve touched on above, the length of time in between paying your expenses and collecting payment can be crucial in making your business sustainable. Getting cash back in quicker will give you more flexibility, so you could try negotiating shorter payment terms with your customers. One option is to offer a small discount for paying early.
And if you’ve perhaps been too relaxed about collecting receivables in the past, it might be time to chase payments and re-stress the importance of paying on time to your relationship.
Bring in more revenue (or reduce expenses)
While it might seem a little obvious, bringing in more revenue is a great way to increase your cash flow.
Tactics to help you achieve this could include increasing your product margins or improving your marketing efforts. Reducing unnecessary expenses meanwhile, such as unused software subscriptions, will also help to free up more cash.
Use external finance
Another option business owners commonly explore to boost cash flow is external finance. In fact, boosting cash flow is the number one reason why SMEs apply for finance in the first place according to British Business Bank research.
There are various financial products out there designed specifically for this purpose. This type of lending is ideal for short to medium-term needs, with short repayment terms as a result. Read more on our Cash Flow Finance page or speak to our finance experts today if you think this option could suit your situation.
Your cash flow cycle is just one important part of your business’ finances. We want to provide the support you need to run your business with confidence - and you can find more informative guides like this one in our Finance Glossary.
14 October, 2021