What it means
Money leaves a business in a steady stream of payments, some fixed in amount and date (payroll, rent, loan instalments, tax), some variable with activity (materials, freight, commissions), some discretionary (marketing, travel, capital purchases, dividends). Cash management begins by knowing the stream: how much goes out, to whom, when, and which items can be moved.
Operating outflows are the running costs paid in cash: suppliers, wages, rent, utilities, insurance, professional fees, and tax on profits. Investing outflows buy the future: property, plant, equipment, software, acquisitions, investments and loans made to others.
Financing outflows service capital: interest (operating under US GAAP, operating or financing by choice under IFRS), loan and lease principal repayments, dividends and share buybacks. The cash flow statement's separation lets a reader see whether the business is covering its running costs, how much it is investing, and how much it is returning to or repaying its funders.
Forecasting outflows is largely a matter of listing commitments. The payables ledger gives supplier invoices and their due dates; the payroll calendar gives wages and their taxes; leases, loans and standing orders give their dates; the tax calendar gives instalments; the capital programme gives project payments.
Variable costs are estimated from activity. The forecast is usually accurate to a few percent, and the errors come from surprises (a breakdown, a legal bill, a supplier demanding early payment) rather than from the known commitments.
Managing outflows in the short term uses three levers. Timing: paying on the due date rather than early keeps cash in the business at no cost; scheduling payment runs to fixed dates gives control; and, in a squeeze, negotiating deferrals with suppliers, landlords and tax authorities buys time.
Amount: challenging every discretionary payment, capturing discounts that pay, avoiding penalties by paying tax and critical suppliers on time, and eliminating duplicate and erroneous payments. Necessity: deferring capital expenditure that does not yet earn, cutting spending that produces no return, and, in a crisis, suspending dividends and drawings.
Control over outflows is where fraud and error concentrate, because every payment is an opportunity: a supplier that does not exist, an invoice paid twice, an employee that has left, a bank detail changed by a fraudster. The controls are authorisation (a valid obligation, approved by someone with authority), segregation (the person who sets up a payee is not the person who approves the payment), matching (invoice to order to receipt), and reconciliation (every payment on the bank statement traced to an approved document).
Outflows also show strategy. A business whose investing outflows exceed depreciation is growing its asset base; one whose financing outflows are dominated by repayments is deleveraging; one whose dividends exceed its free cash flow is returning capital it has not generated.
In practice
Real-world examples.
Example
A software company's largest outflow is payroll, paid on the 25th, so its cash forecast is built around the 25th of each month.
Example
A construction company's outflows to subcontractors are timed to the certification cycle, and it pays them only after its own client has certified.
Example
A retailer defers a $2 million store refit when trading weakens, keeping the cash for stock ahead of the peak season.
Think of it
“Cash outflows are all the streams of money leaving your business-for supplies, wages, loans, taxes, and investments.
Formula
Calculation
Total Cash Outflows (period) = Operating outflows + Investing outflows + Financing outflows
Payments to suppliers = Opening payables + Purchases in period minus Closing payables
Cash retained by paying on due date = Daily purchases x Days of early payment eliminated
Worked example. A regional bakery chain's outflows for a month:
- Suppliers (flour, dairy, packaging, energy): opening payables $410,000; purchases $620,000; closing payables $440,000; paid = $410,000 + $620,000 minus $440,000 = $590,000
- Payroll: net wages $380,000; employee and employer taxes paid $140,000 (previous month's)
- Rent for 18 shops: $95,000
- Van leases (principal $14,000 and interest $2,000): $16,000
- Corporation tax instalment: $60,000
- Two new ovens: $85,000
- Loan repayment: principal $25,000, interest $9,000
- Owner's dividend: $40,000
Classification:
- Operating outflows: $590,000 + $380,000 + $140,000 + $95,000 + $2,000 (lease interest) + $60,000 + $9,000 (loan interest, classified as operating) = $1,276,000
- Investing outflows: $85,000
- Financing outflows: $14,000 + $25,000 + $40,000 = $79,000
- Total outflows: $1,440,000
Against inflows of $1,470,000 (almost entirely shop takings), cash rose $30,000. Operating inflows of $1,470,000 against operating outflows of $1,276,000 gave $194,000 of operating cash flow, which funded the ovens, the debt principal and the dividend with $30,000 to spare.
Timing lever: the bakery pays supplier invoices on average 8 days before their due date because the bookkeeper runs payments when invoices are approved. Purchases are $620,000 a month, about $20,700 a day. Paying on the due date would keep $20,700 x 8 = $165,000 in the bank permanently, at no cost to supplier relationships, and would save about $11,600 a year of overdraft interest at 7%.
Squeeze scenario: a month in which takings fall 15% to $1,250,000 (a heatwave) leaves $1,250,000 minus $1,276,000 = minus $26,000 of operating cash flow before the ovens, debt and dividend. Triage: the ovens are deferred ($85,000), the dividend is skipped ($40,000), and the tax instalment is confirmed as payable on the date (penalties make deferral expensive); the month ends $145,000 better than it would have and the overdraft is not needed. The suppliers are paid on time, because the bakery's flour supplier is on tight terms and the bakery cannot trade without it.Case study
Seen in the real world.
An engineering company with revenue of $18,000,000 discovered, during a cash squeeze, that it had almost no idea of its outflows beyond payroll. Supplier invoices were paid by the accounts clerk as they came in; direct debits had been set up over the years for software, vehicles, insurance and subscriptions that nobody reviewed; capital items were bought by department heads on their own authority; and the managing director approved payments by signing whatever was put in front of him. The finance manager built a payments calendar listing every recurring outflow with its date and amount, a payment run on alternate Fridays for supplier invoices due, an approval threshold of $5,000 above which two signatures were needed, and a quarterly review of direct debits.
The review found $48,000 a year of subscriptions and services no longer used. The payment run kept an average of $220,000 more in the bank by paying on due dates. The threshold caught a $30,000 machine purchase for which cheaper alternatives existed.
Within six months the company's cash position had improved by about $300,000 with no change in sales, and its cash forecast, which had been unreliable, became accurate to within 3% a month ahead, because the outflows were now known. The finance manager's note recorded that the company had been managing the money it received with care and the money it paid out with none.
Watch out
Common mistakes.
- Paying supplier invoices on receipt or approval rather than on their due date, which gives away weeks of cash for nothing.
- Letting direct debits, subscriptions and standing orders accumulate without review, so that outflows continue for things no longer used.
- Allowing one person to set up payees, approve payments and reconcile the bank, which invites both error and fraud.
Questions
People also ask.
What is the difference between a cash outflow and an expense?
An outflow is money paid; an expense is a cost recognised in profit. Buying a machine is an outflow but not an expense (it is depreciated over time); accruing a bonus is an expense but not yet an outflow.
Which outflows should never be deferred in a cash squeeze?
Payroll, tax where penalties or director liability apply, secured lenders, and suppliers the business cannot trade without. Everything else is negotiable.
How often should payment runs be made?
Weekly or fortnightly on fixed dates, so that invoices are paid on or just before their due date and urgent payments are exceptions requiring specific approval.
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