Whether you are running a business or managing the household finances, cash flow is critical.
The difference between cash coming in and cash going out in any given period of time is the net cash flow. If it is positive, your cash balances will increase and if it is negative,your cash balances will decrease.
The easiest way to grasp the concept of cash flow is to think of a water tank. Imagine a pipe at the top of the tank bringing water in from an external water supply. At the bottom of the tank, imagine a pipe taking out water to be used for a multitude of purposes.
The water in the tank will rise and fall depending on whether more water is coming in than going out.
Cash flow is easy to manage when the flows are constant. It is not so easy when there are large variations in cash flows, for example, in small or expanding businesses, in households where income comes from self-employment or from commission, and in property investment. Without careful management the tank can run dry, with disastrous consequences.
The principal tool for managing cash flow is planning.
With a cash flow forecast, that is a month-by-month analysis of estimated money coming in and estimated money going out, you can estimate the net cash flow and the impact this has on cash balances.
You can then put strategies in place to cover the periods when there is likely to be a large negative cash flow - by perhaps altering the timing of payments, borrowing funds, finding additional sources of income or cutting down on expenses.
Many businesses, property investors and households have come to grief when the tank runs dry and there is no contingency in place.
Don't be one of them.
Liz Koh is an authorised financial adviser. The advice given here is general and doesn't constitute specific advice to any person. A free disclosure statement can be obtained by calling 0800 273 847.
