In basic terms, the net cashflow of a business is a term to describe the balance of incoming funds and outgoing expenses. For example, stock that your business buys constitutes an outgoing expense, while a client buying that stock will give your business incoming funds. If a business has enough funds coming in to cover all outgoing costs it has a balanced cashflow. The definition is the easy part, however managing that cashflow balance is as essential to a small business as oxygen is to the human body. If you don’t have the funds to pay for inventory, employee wages, facilities, taxes or to service business debt, your business is on track to failure. Therefore, managing cashflow, and making sure you have money in the bank when you need it, is a vital function of business management.
Working capital is the amount of cash that a business has on hand to cover all day-to-day expenses. Think paying bills, making payroll, rent, buying new products etc. You may have sold your products or services to a client, but until they pay you, that incoming money is useless to the function of your business.
A healthy cashflow can directly lead to growth of a business. If an organisation has a good amount of working capital, they can sustain their daily operations, leading to higher profits and enabling re-investment. But aside from keeping up with day-to-day expenses, SME’s need to have a healthy reserve of cash for expenses relating to the future of the business. Think of it as the amount of cash you have in your wallet at any point in time - if you spot a great deal but have no money, you can’t take advantage of that opportunity. The same logic applies to a business, it is important to have adequate working capital to take advantage of any unexpected opportunities for expansion that may arise.
We’ve all heard about the dismal rates of failure of new businesses, and one of the main reasons cited by CEOs of failed start-ups is that they’ve run out of cash. Regardless of the size of the business, if the expenses of that organisation are greater than the cash available, you have a cashflow problem, and you may not be able to get ahead enough to see your business prosper beyond the first few years.
There are some ways to increase the working capital of a business.
For any new business the first four are ether key focus but sometimes there’s only so much you can do, which leaves external finance as the only other method to increase cashflows. Traditional finance providers are generally hesitant to provide funding to smaller enterprises due to a lack of historical track record, which leads to high interest rates, inflexible contracts, requirements for personal security guarantees and a lengthy application process. In Australia, the big banks own around 80% of the SME lending business, and according to Kate Carnell from the Small Business and Family Enterprise Ombudsman “the big four banks are not lending to small business unless they have a significant equity in property”, .p As a result, many smaller enterprises in need of funding are failing simply because their ability to borrow is severely limited.