The importance of cash flow

It’s nothing new that finance is the heart of a company, right? By extension, financial resources are the blood that circulates through all the organs and members of a company.

It provides a diagnosis of the company’s accounts

Perhaps you found it strange what we said at the beginning of this text, about how companies with large revenues can also be in financial difficulties. Although the common sense is that very large enterprises cannot go bankrupt, the truth is that, if costs are very close to revenues, this is indeed possible.

In any diagnosis of the financial situation of a business, the first step is the cash flow analysis. By measuring income and expenses, you will know whether the business has made a profit or a loss. Even when revenues are high, revenues must be sufficient to reach the break-even point: they must be sufficient to cover expenses, and the business is at least “zero to zero”.

Gives the real dimension of your profits

Still, what is expected of any company is that it makes a profit, isn’t it? The entries need to be sufficient to provide a return much higher than the investment, in order to offset the so-called “opportunity cost”. After all, if it weren’t for the profit, the owners could allocate the resources in other companies or in the financial market.

Without an effective control of finances that only cash flow allows, you and your company walk in the dark. On the contrary, with real-time monitoring of inputs and outputs, you will be able to make decisions based on numbers and improve business performance.

Relates to the operating cycle

Two concepts are extremely important for you to define the positive or negative result of your business: the cash cycle and the operating cycle.

The cash cycle or financial cycle comprises the time from the payment of the raw material to the supplier until the customer receives the products or services marketed.

For example, if the company pays for inputs on the 5th of the month, but only receives sales on the 20th, it will have to find financing for 15 days. If she has available cash or working capital, she can go through this period without any problems. If you don’t, you’ll need to get loans, which can be expensive and hurt business performance.

What is operating cycle

The operating cycle, in turn, covers the period from the moment of purchase of raw materials to receipt by the end customer. Let’s imagine a situation: the company purchases inputs on the first of the month.

This material is stored until the 10th. From the 11th to the 15th it is transformed to become the final product. Even so, it is only sold on the 25th. On the other hand, receipt for the sale occurs only on the 5th of the following month. In this case, the operational cycle lasted 35 days, the effective inventory period was 25 days and the accounts receivable period was 10.

Still based on this example, let’s assume that the payment of suppliers occurred on the 15th and the receipt by the end customer continues to be on the 35th. In this case, the cash cycle lasted 20 days. The business needs to make money to finance itself during this time, otherwise it will pay interest for debt arrears.

In a situation like this, the ideal is to gradually reduce your cash cycle, gradually ending the need for financing. The most recommended thing, by the way, is that it is always negative. This occurs when the company only pays the supplier after having received it from the customer.

Enables better financial organization

To have the company “in the palm of your hand” and know how much funding the business will need during the cash cycle period, you can use the cash flow projection.

In our previous example, it would be possible to identify the forecast of departures for those 20 days and, based on that number, prevent the company’s cashier from going into the red. That’s why working capital is so important: for the business to remain firm while waiting to receive credit sales.

You can also try to shorten the operational cycle through logistical improvements, production layout, employee performance or other type of change. You can also reduce or make the cash cycle time negative by negotiating with suppliers and anticipating receipts from customers.

Note that, in order to identify where to improve internal processes with the aim of making financial management more efficient, the company must monitor the entire operational cycle.

An ERP ( Enterprise Resource Planning) software helps a lot in this task. The use of a computerized system makes controlling deadlines and flows much easier and less subject to errors. Especially when you need to track multiple products or services at the same time on a massive scale.

An efficient cash flow

Remember the comparison we made with Formula 1? Because let’s go back to it to explain one more important thing: the strategist of a motorsport team needs data to make decisions, such as the number of stops for refueling and changing tires, right? He needs to know, for example, the timing and telemetry of the car.

In financial management it is no different: accurate information will be needed that the cash flow movement provides. Ideally, the company’s cashier should always be in the blue, that is, positive.

Initially, the manager must monitor the flow of funds over a certain period, to assess whether there are occasions when the balance is negative. If yes, he has to find out the causes of this situation, to correct them. After all, the shorter the cash cycle, the smaller the need for external financing.

Bear in mind that, in principle, the best thing is for the company to be self-sufficient from the financial point of view, since the cost of equity capital is much lower than that of third parties. Even to know if it will need resources in a certain period, the company will have to consult the cash flow or a chart of accounts.

With adequate monitoring of financial transactions, it is possible to plan to reduce the cash cycle or financial cycle and, thus, not depend on external resources. Furthermore, in a possible expansion, the organization can dimension the necessary investment well, so as not to leave cash uncovered.

a practical example

One of the biggest mistakes made by entrepreneurs is the lack of cash flow monitoring throughout the entire operational cycle. For example, if this cycle is long, the manager can easily get lost in the accounts, if he does not control them.

In an operating cycle of 180 days, for example, you may get excited about the positive balance in the period, say, between the 30th and 40th and make a withdrawal of funds for personal use, purchase of equipment or expansion of your facilities.

In a case like this, if the company needs to pay suppliers later, on day 90, for example, but will only receive from customers on day 180, the company will have a cash cycle of 90 days.

If the cash balance is in the red for three months and the company needs to resort to loans, it may be weakened by financial problems. To prevent something like this from happening, you must be methodical with your cash flow. Preferably, have software to automate it and avoid wasting time collecting and evaluating data.

Keep in mind that your goal is to keep your cash balance always in the black. Thus, it will be possible to buy,  manufacture , sell and receive while honoring commitments to suppliers, taxes, inspection and employees.

Advantages and benefits of good cash flow

In the past, it was common for entrepreneurs to use their own experience to make purchases, decide production quantities, carry out special sales actions, etc. Due to the difficulty of controlling input and output data in the company, it was in fact more difficult to carry out more accurate calculations.

Nowadays, however, with the use of computerized systems such as ERP software — which integrate various processes within the production chain — monitoring business data has become much easier. It is possible to plan the supply of goods and prepare financially much earlier and with less risk of shortages.

Enables medium-term planning

With the thorough evaluation of cash flow, it is possible to find patterns of inflows and outflows. For example, in retail companies it is normal to have a revenue peak at the beginning of the month, when consumers receive their wages and go shopping.

Knowing this and having reliable data, the business can schedule production and inventory, also based on the operational cycle. Thus, the organization does not fail to meet demand and, as a consequence, does not lose sales or profit.

Speaking of profitability, you may not know if the business actually has a positive balance or, then, realize that the surplus is not enough to offset the opportunity cost. Undoubtedly, cash flow fills this lack of information. It will be possible not only to know the total balance between income and expenses, but also to evaluate these two classes based on the groupings of each one.

Helps understand business changes

If there was a spike in inputs or outputs, you’ll be able to track the values ​​and know exactly where a sudden change occurred. With this, you can even identify changes in customer consumption data.

For example, if a new neighborhood comes into existence in the city, it is natural for sales to increase. Even if this is good for the company, it must plan to keep supply at satisfactory levels, right?

On another occasion, if costs increase significantly, you can also use cash flow analysis to find out where there was an increase and, based on this data, change processes to return to the previous situation.

In some cases, the cash flow can even be used to identify waste of raw materials or deviations of any kind. After all, if the data has patterns and changes suddenly, it is because there was a cause that must be investigated.

Contributes to the projection of income and expenses

In addition to showing an accurate picture of the financial situation of your business at a given moment, cash flow can be very useful for planning this area of ​​the company, by projecting revenues and expenses.

This is usually done on an annual basis. Therefore, by assuming daily, weekly or monthly input and output data, you can see the cash flow behavior during the year. Of course, this is only possible with the use of an automated tool, such as management software.

As he simulates inflows and outflows, the manager monitors the evolution of cash flow in different scenarios and, thus, can predict a period with a negative balance. For example, at the beginning of the year when tax payments pile up and weigh on your bills.

If working capital is not enough to overcome this pressure on finances, it is good for you to know as soon as possible that you will need alternative means to generate income without taking out loans.

In some cases, offering discounts on cash purchases is a good option to anticipate the entry of funds at the cashier. In this way, it prevents the balance of income and expenses from going into the red during the period when most accounts are due.

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