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Positive and Negative Cash Flow

Cash flow is a useful metric that can be used by businesses of all sizes to gain an understanding of their financial performance. Cash flow essentially refers to the amount of money coming into or out of your business over a given period of time. Typically, it is calculated on a month by month basis.

Cash flow can be positive or negative, and can fluctuate greatly from month to month depending on the level of outgoings or income. Businesses can use their cash flow statements to project the financial effects of different investments. Allowing for a greater understanding of the viability of a new investment or of business growth in the near future.

 

Positive Cash Flow

A business will experience positive cash flow when their net income is greater than their net expenses over a  given period of time. Positive cash flow indicates that your business has enough cash to cover operating expenses and other outgoings, and have some cash left over. Also known as having surplus liquidity. 

Take for example, an eCommerce business who generates £80,000 from selling their product to their customers in a given month. But they have to pay £10,000 to replace some worn-out equipment, £5,000 for their monthly loan repayments and £20,000 for restocking products. Once they take away these operating expenses from their cash revenue, they will have £45,000 left over. So have a positive cash flow for that month.

Having a positive cash flow is an ideal situation for any business to be in. Having a positive cash flow will remove the need to take out any loans to cover your usual expenses and ensure that you can pay your suppliers and staff on time. Additionally, positive cash flow gives you the opportunity to reinvest in your business, upgrading equipment or processes that will help forward your growth. Effective cash flow management is the key to success for your business, and will give you peace of mind for the period ahead.

 

Negative Cash Flow

Negative cash flow is simply the inverse of positive cash flow, occurring when your business has more cash outgoing than incoming over a period of time. In a time of negative cash flow you will find it is challenging to cover your expenses from that period.

Your business may experience negative cash flow for a variety of reasons, such as having to pay a one off large expense that month to cover the cost of a system that needed replacing, or experiencing delays in a client paying you for a large order. 

It is possible for a business to experience negative cash flow but still be profitable. In both of these examples, while the business may be experiencing negative cash flow at this period in time due to a short-term issue, they are likely to see positive cash flow in the following months.

 

Risks of Negative Cash Flow

While experiencing negative cash flow does not necessarily mean that your business is not profitable, it can bring with it certain risks. 

Not having the cash to hand to pay bills, taxes or suppliers on time can force businesses into taking out short-term loans. If your business has a good working relationship with suppliers, you may be able to pay for the month’s resources on credit. However, suppliers will only be willing to do this so many times as allowing customers to pay on credit affects their cash flow too. 

You may find that if you are not able to pay suppliers, you will not be able to restock your products to meet demand. In turn, this decreases your revenue potential for the coming period, leaving you susceptible to another month of negative cash flow, which could have an equally negative impact on future months.

Negative cash flow makes it very difficult to reinvest in your business, stunting your growth. If your business starts to experience prolonged periods of negative cash flow, it could threaten the survival of your company altogether.

 

Mitigating the Risks of Negative Cash Flow

Although periods of negative cash flow can be unavoidable, there are methods you can take to mitigate the impact of these periods on your overall financial health, and reduce the likelihood of them occurring again in the future.

In the previous example, a business was experiencing negative cash flow as they were waiting for a customer to pay for their large order. To avoid this repeating, consider implementing a policy which requires customers to pay for large orders within a specific time frame. This will avoid your business having to pay the suppliers for the product long before you receive payment for the items, helping to reduce the window of negative cash flow.

On a larger scale, your business could consider diversifying it’s income. Having multiple revenue streams will manage the risks of one area of your business experiencing lower revenue in a particular month, and work to prevent your business from experiencing negative cash flow as a result. As an eCommerce business selling products, you could consider offering paid online courses or subscriptions alongside your usual stock. 

An effective way to increase revenue without creating significant increases in your overhead costs, is to take steps to increase your average order value. Running a short term deal on your website that encourages higher order values over a few days or a week could help your business to mitigate the risks of a negative cash flow month, and allow you to pay your suppliers and bills on time. For example, you might introduce a discount on orders over a certain amount, or increase the number of loyalty points a customer will receive for a higher value order. 

 

Conclusion

Understanding the impact of positive and negative cash flow on your business can be crucial to your company’s success and survival. While cash flow does not equate to profitability, and as such should always be taken with a pinch of salt, taking the time to manage your cash flow, consider alternative revenue streams and ways to boost your income can hugely benefit your business’ profitability and growth potential. 

To learn more about effective cash flow management, how to calculate your business’ cash flow or create a cash flow forecast, download the rest of our eBook, or get in touch with our payment experts for further advice and information.

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