Cash flow is important for everyone – you can’t have more money going out than you have coming in. Everybody cash flows to a certain extent, a PAYG employees knows they get paid every two weeks on Wednesday, they know their salary amount and so they budget. They know when they have to pay certain bills, and save the money so that they are able to cover those costs, they spoil themselves when they have a little left over, but, if they have budgeted correctly, they will either always break even or have a little money left over from their salary.
However, there is one key aspect here – the PAYG employees know when their next pay will go into their account. It’s regular, on time and something that they don’t have to actively chase. This makes organising their own individual budget and cash flow a little easier.
Contractors, on the other hand, don’t have this certainty as to when and where their next payment. They need to find a contract, and then they are reliant on their invoices being fulfilled on time. Further, a contractor needs to take into account tax and super, two aspects that a PAYG employee does not have to consider.
Therefore cash flow is crucial to a contractor, just as it is crucial to a business, but why exactly is it so important?
What is cash flow?
We’ve used the term quite a bit above, giving a general description of what could be construed as cash flow, but to give a more precise definition, cash flow is the net change, it’s your cash position from one period to the next. If you have taken in more cash than you send out, then you have a positive cash flow. You have a negative cash flow if you have more cash outflow then inflow.
It’s important to note that cash flow is not simply having a surplus of cash at a point of time, this is called cash position and while having a positive cash position is crucial, a positive cash flow indicates an ongoing ability to generate and use cash in a sustainable manner.
Why is it important?
‘Cash is King’ as the well know expression goes. Having a strong cash flow is a good indication of financial health, and having a positive cash flow, meaning more money coming in than you are spending, places you in a more stable position. It provides protection should you run into issues later on, including loan defaults or foreclosures.
If a contractor is able to accurately manage their cash flow, it also provides greater security for the future when the available contracts may not happen regularly, or if a client does not pay an invoice in time. It’s a small buffer to ensure that you don’t find yourself in a position where you have outstanding payments that you’re unable to fulfil.
It’s crucial for a contractor, or a business, to attempt to have a positive cash flow, as it promotes growth, it allows you to invest confidently to expand your services, which it turn means you may be able to increase your fees.
Having a positive cash flow also affords you greater flexibility – flexibility in responding to dilemmas or making critical decisions.
While it’s possible to get a loan to assist with cash flow, always be wary of where you are getting the money from. Some companies offer cash flow solutions, to help a business establish itself, and it’s also potentially possible to get a loan from the bank. However, you need to be aware of just whose money is in your bank account. If the majority of your cash position is credit that you have been loaned, you won’t have the same flexibility and confidence to spend that money that you would have if the money was exclusively yours. It’s also essential to note that if the monetary amount that you have on credit, and therefore owe to your creditors, is greater than the amount of money you have coming into your account, you have a negative cash flow.
It’s also important to not just focus on the idea of profit. Receipts can often lag behind sales, or you may have had an invoice recently paid into your account, but you still have an outstanding invoice of your own that you need to pay, or the loan you took out originally has come due. Profit is important, but make sure you look at the bigger picture to understand your cash movements and make sure you aren’t caught out.
Talk to your accountant, or an outsourced qualified CFO service, to get an explanation on how you could improve your cash flow situation, and even get them to put together a cash flow forecast for you.
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