How to manage your business cash flow

Cash flow is the money flowing in and out of a business, recorded when the money actually moves. It is not the same as profit. Under accrual accounting, income can be recorded before the customer pays, so a business can show a profit and still struggle to pay its bills if money comes in more slowly than it goes out.

Profit measures what the work earned over a period once its expenses are counted; cash flow measures the money that actually reached or left the bank in that time. business.gov.au's glossary defines profit as total revenue minus total expenses, and revenue, also called turnover, as the amount earned before expenses. None of those figures says when the money arrives.

The two drift apart for three reasons:

• Timing. When income and expenses are recorded on an accrual basis, a credit sale counts towards profit in the month you invoice it but reaches the bank only when the customer pays. Supplier bills work the same way in reverse.
• Cash that leaves without being an expense of the month, such as paying back part of the amount borrowed on a loan or buying a large piece of equipment outright. How each one is shown in your accounts is a question for your accountant.
• Cash that arrives without being a sale, such as a new loan paid into the account or money an owner puts into the business.

Read the two columns side by side. The month's jobs made a profit of 14,800.00, yet the bank balance rose by only 3,000.00. Customers paid 7,500.00 less than was invoiced, because much of what came in was for earlier work and some of this month's invoices aren't due yet. Supplier payments ran 2,800.00 above the month's costs, because bills from the month before fell due. Another 1,500.00 went on the loan. Together those three gaps make up the 11,800.00 difference.

So is a business with positive cash flow also profitable? Not necessarily. A month can look strong in the bank because old invoices were finally collected or a loan came in, while the work done that month made a loss. The reverse can happen to a growing business: profit climbs while cash gets tied up in unpaid invoices and extra stock. Both views are correct. Profit tells you whether the work pays; cash flow tells you whether the bills can be paid this week.

business.gov.au publishes a free cash flow statement template. Each month follows the same steps:

1. Start with the opening balance: your bank balance in the first month, then the previous month's closing balance.
2. Add cash incoming, such as sales, payments from debtors and grants.
3. Take away cash outgoing, such as purchases, rent and rates, utilities, and advertising and marketing.
4. The result is the closing balance, which becomes next month's opening balance.

business.gov.au suggests updating the statement regularly to spot payment cycles and seasonal trends, so you can prepare for busy times and plan for quiet periods.

A cash flow forecast is the same statement filled in with estimates for future months. business.gov.au describes it as a tool to help you see whether you will have enough income to cover your costs, so you can prevent cash shortages and avoid debt.

Base the estimates on previous years: look for seasonal trends, regular sources of income and your major costs, and put each one in the month the money is likely to move, not the month the invoice is dated. Label estimated figures clearly so they are not mistaken for actual ones.

A short check on the same day each week is how you monitor cash flow between month ends. Among business.gov.au's steps for getting a struggling business back on track is reviewing and updating the financial records every week to identify problems early, and the same habit is useful well before there is any problem. Once the books are kept up to date, the check is a small job:

1. Bring the books up to date: match the week's bank transactions and enter the invoices and bills that came in.
2. Note the balance of each business account, then take away any money already set aside for known costs, so you can see what is actually free to spend.
3. List the customer payments due in the next fortnight, and follow up any that are overdue.
4. List the bills due in the next fortnight and decide when to pay each one, keeping to the terms you agreed with the supplier.
5. Roll the 13-week view forward: swap last week's estimates for the actual figures and add a new week at the far end.
6. Move money into the separate account for upcoming costs, if that is part of your plan.
7. Write down anything that needs a decision, such as a large order to fund or a customer who keeps paying late.

Once a month, add the slower checks: reconcile every account to its statement, update the monthly cash flow statement, and put the profit and loss statement beside the budget. business.gov.au suggests scheduling time each month to compare spending with the original budget, and updating a forecast monthly or quarterly. Keep each week's version of the 13-week view, or a note of what changed, so you can later see how close your estimates were and adjust the next ones.

A 13-week cash view is the cash flow statement set out by week instead of by month, covering roughly the next quarter. Weekly columns matter because many payments land on fixed dates, so a week can be short of cash even when the month as a whole looks fine. The method is the same as for a monthly forecast, which has its own guide: start with the cash in the bank, add the receipts you expect each week and take away the payments due.

Read down the closing column. Weeks 1 to 5 are steady: rent and the insurance premium pull the balance down in the weeks they fall, and it recovers. Week 7 is the first pinch, at 1,500.00, because the oven deposit and the licence renewals land just before the event client's payment. Grouped into months of 4 weeks, the same figures would close the second month at 7,100.00 and the pinch would vanish. From week 10 the school holidays cut orders while costs carry on, and the balance drops below zero in week 12.

Seeing this three months out leaves room to act. The owner could move the oven deposit to week 8, after the event payment, ask event clients for a deposit when they book, and set money aside in the busy weeks to carry the quiet ones. business.gov.au suggests deposits for special orders as one way to encourage early payment, and planning to have enough cash to get through known quiet periods. A spreadsheet with one row per item and one column per week is enough; business.gov.au's free cash flow statement template is a spreadsheet set out by month, and the same rows work with weekly columns.

• Send each invoice as soon as you make the sale, and keep a copy for your records.
• Set clear payment terms, such as payment up front or within 30 days, and put them on your invoices and contracts.
• Decide how you will collect overdue payments, and follow up customers who haven't paid.
• Review your payment terms regularly to make sure they still suit the business.

business.gov.au suggests talking to suppliers about terms and pricing that suit your business. A longer payment term, such as 60 days instead of 30, lets you hold on to cash for longer, and committing to regular orders can earn a lower price.

Review your costs for savings, and manage stock carefully: regular stocktakes show what is selling, and reordering only when needed keeps cash from sitting on the shelf.

Put money aside regularly in a separate bank account for costs you know are coming, so the cash is there when they fall due. Include employee costs such as wages and allowances in your budget and cash flow statement.

Keep a list of due dates, with reminders or scheduled payments. Depending on the business it might include payroll tax, licence renewals, supplier invoices, rent and loan repayments.

Compare your estimated and actual income and costs regularly, so a shortfall shows up early. If one does, you can reduce costs, follow up overdue invoices or revise your budget.

business.gov.au lists warning signs that cash flow is under pressure: struggling to pay bills, relying on credit and delaying payments to suppliers. Acting early, and getting advice before a problem grows, gives you more options.

A few habits make cash much harder to manage, and each one shows up in the books before it turns into a missed bill.

• Treating the bank balance as money to spend. To spot it, add up the bills due in the next fortnight and the money you meant to put aside; if the total is more than the balance, the balance was never spare. To fix it, work from what is left after known commitments, as in the weekly routine.
• Reading a profit as spare cash. It shows as a profit on the profit and loss statement while the bank balance keeps falling. Put the cash flow statement beside it each month and trace where the cash went, for example into unpaid invoices, stock or loan repayments.
• Letting overdue invoices drift. The list of unpaid invoices by age shows more in the older columns each month. Set a process and keep to it: business.gov.au suggests starting with a polite reminder by phone or email, because some late payments happen simply because the customer forgot.
• Holding more stock than you sell. A stocktake turns up lines that haven't moved for months. business.gov.au's suggestions include clearing out stock that isn't selling, is out of date or is no longer useful, and reordering only when needed.
• Covering everyday costs with an overdraft. The overdraft is drawn at most month ends, not just in the odd tight week. business.gov.au describes an overdraft as useful for bridging short-term cash flow gaps but not something to rely on for long-term financing, so use the cash flow statement to find what is causing the gap.
• Paying every bill the day it arrives. Suppliers are paid weeks before their due date while your own customers take their full terms. Pay on the date the supplier set, unless paying early earns a discount you have decided is worth more than the cash.
• Looking at cash only when it runs low. The first sign of trouble is a declined payment or an anxious look at the balance. A weekly check and an up-to-date forecast replace guessing with dates and amounts.

Positive cash flow means more cash came into the business than went out over a period, so it closes the period with more in the bank than it started with. In business.gov.au's cash flow statement template that is a monthly cash balance above zero: total cash incoming less total cash outgoing.

No single figure makes cash flow good for every business. A more useful test is whether the business can pay each bill when it falls due, through the quiet months as well as the busy ones, without leaning on credit. Judge that against your own figures: the month before, the same month last year to allow for the seasons, and what your forecast expected.

Look at what produced a positive month before reading much into it. Cash from trading, meaning customers paying for work and goods, tells you something about the business. Cash from a new loan or an owner's contribution only tells you the balance went up. The pattern over several months says more than any one result.