There are a mountain of accounting and finance terms which baffle even the most business-savvy entrepreneurs. Understanding the terms and improving your business's performance on each can make a big difference to how your business operates and how successful it becomes.
This article will to demystify operating cash flow and offer practical tips for improving it.
What is Operating Cash Flow?
Accountants often abbreviate operating cash flow to OCF - so now you'll know what they mean! OCF is a measure of the amount of cash generated by a company's normal business operations (sales) minus the cash required to pay for its investments.
Cash generated from sales is a simple equation: Cash from sales minus cash required to pay suppliers.
Deduct the cash required each month for longer-term investments (such as equipment purchases with phased payments or loan repayments) and you've got you operating cash flow.
Operating cash flow is important because it shows you whether your business is able to generate enough money to maintain and grow your business. Understanding your operating cash flow can also highlight any need for external financing.
Now we understand OCF, how do we improve it? Here are our 7 top tips!:
1. Know your Numbers
To successfully manage your operating cash flow, it is essential you have some key figures to hand:
- Revenue (money coming in from your sales)
- Supplier costs (for raw materials and day-to-day expenses)
- Investment costs (paying for longer-term investments)
Calculating each of these requires other numbers of course - but hopefully they're numbers you're more familiar with to manage your operating cash flow.
These figures sometimes fluctuate significantly for a number of reasons; legislation changes, supplier changes or market / economic peaks and troughs. All of these factors will have a direct impact on your operating cash flow.
Keep your eye on these three figures and if you see any dramatic changes coming, you'll know to start looking at the affect they are going to have on your operating cash flow.
2. Forecast Regularly
You'll never regret regular forecasting - it can be worth its weight in gold, if only because it gives you the chance to do prepare and take action rather than panic and react!:
- You can identify any potential hazards ahead of time
- You can plan for future growth
- You can experiment with potential contingency plans so you are prepared
- You can run scenarios without risk
Forecasting, in terms of managing your operating cash flow, will help you to spot any potential problems with your operating cash flow. Forecasting can also help you work out the best plan of action to take if things start to look bleak - and this sort of thinking definitely benefits from a little space and time.
Forecasting gives you peace of mind and confidence in your business's financial health.
3. Regularly Review your Growth and Operating Plans
Your plans for the business (and you must have plans!) are interlinked with your business's operating cash flow. If one changes it will affect the other and vice versa. The cash flow your business is operating with could be improved which could, in turn, allow you to implement your growth plans more quickly than you thought possible. Equally, if the plans for the business change for some reason it could impact the operating cash flow and have a knock on affect to other parts of the business.
For example you might be looking to upscale operations in the next 3-5 years or implement an exit strategy. These are just two of the reasons you may be reviewing your business plans but whatever the reason, your operating cash flow is a figure you will need to have at hand and fully understand in order to deliver on your plans for the future.
Your business plans and operating cash flow are intertwined, so regularly review and careful management of one will help you to manage the other!
4. Don’t Let Debts Build - Theirs or Yours
Operating cash flow looks, in part, at cash coming into the business from sales revenue. Unfortunately, sometimes your customers don't pay within your payment terms. If this is the case, it is essential these debtors are managed efficiently.
Don’t be afraid to take prompt action to recoup sales revenue because outstanding debts could have a serious, negative, impact on your operating cash flow. This could then have a wider impact on the business if left to escalate.
It's also possible that your business may have outstanding debts you owe on goods or services you've received. This can be almost as damaging:
- Your reputation will be affected. You need reliable suppliers as well as reliable customers, and if you don't pay on time you will be put to the bottom of the queue - or worse still, cut-off altogether.
- Your sales may be tarnished. This applies most to business-to-business sales, but the internet lets this sort of information travel very quickly, no matter who your potential customers are. People are reluctant to buy from people who treat others poorly or who aren't reliable.
- Understanding a forecasting your operating cash flow position gets much harder. The more invoices and bills there are outstanding for over a month the harder it gets to track everything and get a good idea of what's your money and what's owed.
Mounting debts hurt both the supplier and the customer - take prompt action if something starts to slip.
5. Know Where your Leakage Points Are
There are some very interesting insights to be found in your list of outgoings. There are cost you can’t avoid, for example suppliers, wages, rent etc. But there are also leakage points in every business which need to be managed.
Leakage points could be: - Raw material wastage - Higher staff costs due to inefficiencies - High or increasing supplier charges - Time and money lost due to "downtime". Process failures almost always carry cost - Business rates
Once each quarter spend an hour looking through your costs - where your money has gone. Like bad debts leakage points can railroad your operating cash flow if not managed carefully - but you can't manage what you don't measure, so take a look and get a bit smarter every quarter
6. Suppliers Cost More Than You Think
Suppliers charges appeared in the list above but a weak supplier could cause leakages
across every one of those bullets - from wastage to increasing your staff costs!
They can have such a big impact they're called-out here into their own category.
There are a number of reasons why we don’t want to change supplier(s): loyalty, hassle, cost etc. However, sticking with the same supplier(s) can be really damaging to your operating cash flow - and you're running a business, right?
Regularly review each supplier and rate them on their: - service - reliability - quality - payment terms - and cost
If a supplier performs badly compared to your others, or if they start to slip, it's time to shop around for an alternative.
Poor suppliers can drain far more than just a direct cost from your business. Have a structured approach to review them regularly or incur a broad range of cash flow leakages.
7. Maintain Multiple Routes to Market
Without sales, there is no revenue - so there is no operating cash flow. All of the business advice available tells us not to rely on one sales channel alone. By looking at your marketing strategy you can identify the different routes to market available for your product or service. This will reduce your exposure to the risk of falling sales due a change in a specific market and increase the probability of securing more customers.
With several routes to market come a more balanced and reliable stream of revenue, making it easier to maintain a steady operating cash flow.
We hope you found this post useful. If you have any comments or questions about operating cash flow or any other business finance issue please get in touch - we look forward to hearing from you!
Don’t forget to follow us on Twitter for all the latest news and blog posts to help you manage your business finances.