Optimizing Cash Flow: Tips From an Accountant

Kia ora, accounting fans!

Across the globe, we’re starting to feel a general slowdown in business. Much of this is attributed to the post-COVID inflation high. Supply chain issues that resulted from COVID and shipping issues have also contributed to increased inflation. Governments around the world are looking at reining in spending. Here in Aotearoa New Zealand, this has resulted in many public sector jobs being terminated. This has created a flow on effect to private businesses, many of whom are laying off their employees and contractors.

This article is written for you, dear reader, as an individual. Some of these tips are relevant to businesses, but since PocketSmith is designed to help families get on top of their finances, we’ll be taking a personal perspective on cash flow. If you’re looking for small business cash flow tips, you can check out our business comic blog at The Comic Accountant. Pour yourself a nice hot drink, and get comfortable — because we’re going to learn how to optimize your cash flow!

Cash Flow vs. Income

A lot of people are confused between cash flow and income. If you’re running a business, the misconception is that profit is the same as cash flow (hint: It’s not!). For families, the misconception is that cash flow is the same as income. So let’s clear that up! Unlike businesses, we don’t have to worry about profit for families, only cash flow matters.

What is income?

Income is the money that you earn as an individual. For salaried workers, this is your take-home pay (after taxes). For business owners, this is the drawing(s) you’ve made from your business. Income is cash coming in from its source. This source is your paid employment or your business.

For example: Amina earns $2,000 a fortnight from her job as a marketing manager. After taxes, her take-home pay is $1,600 a fortnight. Her income, therefore, is $1,600.

If you are a business owner, you want to make sure that you’ve already put aside money for taxes before you pay yourself.

For example: Chandran is a business owner. He has $4,000 cash available in his business. He needs to put aside $1,500 for taxes and leave $1,000 in the business to cover his expenses. This leaves $1,500 cash available for drawings. He then takes the $1,500 drawings as his personal income.

For more details on how to pay yourself as a business owner, check out our pay yourself article.

What is Cash Flow?

Cash flow is the inwards and outwards movement of cash in/out of your family accounts. To keep it simple, we’re going to use cash flow to refer to net cash flow (the difference between your cash inflow and cash outflow). Cash flow can be a negative or positive figure. If it is positive, you have more cash inflow than outflow. If it is negative, you have more cash outflow than inflow. Easy!

For families, your cash inflow will mainly consist of your income. If you sell any of your assets/personal belongings, they can contribute to your cash inflow too, but this rarely happens, so we’ll stick to just income for now.

For example: Amina and her partner have a combined income of $3,100 a fortnight. This works out to $6,200 a month. Each month they have average monthly outgoings (cash outflows) of $5,500. Their cash flow for each month works out to $700.

Cash flow is calculated over a period of time. Generally, I would recommend looking at cash flow on a monthly basis. It is long enough to see income and outgoing trends but still short enough that it is easy to focus on the individual transactions that make up your cash flow.

Understanding the difference between cash flow and income will help you gain better…

Cash flow visibility

Unwatched cash in your spending accounts will always disappear. Remember that. Which is why it is important to have visibility of your cash flow. To gain cash flow visibility, you need to do these two things:

1. Identify your household’s five largest monthly outgoings

Home accounting apps like PocketSmith are really good for this. Using PocketSmith, you can easily identify your household’s five largest outgoings by generating monthly income reports. If you’re not using accounting apps (or are on the fence about one) you can start scribbling down on a notepad what your five monthly outgoings are. You may have to do this based on gut feeling. Or you can track down all your spending receipts. Seriously, just get an accounting app already.

Generally speaking, most households will have the following outgoings in their top five:

1. Rent/mortgage repayments
2. Groceries/food
3. Fuel/vehicle expenses
4. Utility bills
5. Insurance payments

Most households can’t function without these items. Although some households may choose to cheap out on insurance and live life on the edge — but hey, you do you. Note that if you’ve got a lot of commercial (i.e. credit card) debt, debt repayment may bump out one of the above categories from the top five. Whatever it is, to start building cash flow visibility you need to identify these expenses and average them out based on a 12-month average (or gut feel, if you’re not using accounting apps).

For example: Chandran works out the following outgoings for his household’s top five monthly outgoings:

1. Mortgage repayment: $2,900
2. Groceries: $1,000
3. Fuel/vehicle: $400
4. Utilities: $380
5. Insurance payments: $350

In total, Chandran has monthly outgoings of about $5,030.

2. Work out your average monthly income

This one is really easy. For salary workers, your income is simply your take-home pay after deductions. It is trickier for business owners or contractors. Their income tends to fluctuate and you may not be able to accurately predict how much your average monthly income is. Once again, an accounting app like PocketSmith can help tell you exactly what your average monthly income is. Otherwise, you’re going to have to look at your business’ drawings report and work it out from there.

For example: Chandran made business drawings of $4,000 in June, $5,000 in July and $2,000 in August. Averaging the past three months, he reckons his personal monthly income is about $3,600 a month. His partner has a take-home pay of about $3,600 a month as well. Combined, they have a monthly income of $7,200.

This tells you how much you can expect incoming each week. Using Chandran’s figures, we can see that on average his family has a monthly cash flow of $7,200, minus $5,030, which equals $2,170. Ka pai Chandran! But of course, that remaining $2,170 can easily get swallowed up by less obvious expenses (like education, gym memberships, Netflix subs, internet fees, etc). Using PocketSmith to keep track of all your family expenses is the best practice here.

Fortunately for Chandran, his family is staying afloat. However, not all of us are so lucky. Let’s take a look at the next section.

What if your outflows are more than your inflows?

The unhelpful answer would be: Make more money!

Make more money? In this economy? Seriously? The job market is getting tougher which is resulting in less spending, which has impacted businesses, many of whom are going under. So making more money isn’t the best option. So instead of supply-side economics (income), we’re going to look at spending-side economics (your outgoings).

What spending can be cut?

This is a tricky one. First, you need cash flow visibility. So if you haven’t done that yet, get on top of it! Once you’ve identified your monthly outgoings, its time to take your metaphorical money scissors and start cutting.

Rent/mortgage repayments

Sorry, you’re not going to be able to reduce this. You may get a mortgage holiday if your situation is really dire. But even then you’re just kicking the can down the road. If you’re renting, good luck getting your landlord to reduce your rent.

Groceries/food

You can possibly get the most savings out of this category. Here are some tips that I’ve managed to pick up over the years:

1. Eat less meat: No you don’t have to go vegan, but reducing meat in your diet leads to overall savings. This is because meat (especially red meat) tends to be more expensive than plant-based proteins (like beans, legumes, tofu, etc).
2. Buy whole fish, not fillets: Whole fish tend to be less expensive per kilogram compared to fillets. The downside is that you need to gut, scale and clean the fish. Then the fish frames and head (if you don’t like eating the head) can always be boiled to make fish stock.
3. Eat out less: This is an obvious one. Cooking is almost always more economical than eating out.

Fuel and utilities

This one is tough to suggest cuts to without sounding preachy. So I’m not going to. You can’t always rely on public transport at all times and it’s always hard to save on power in winter. Do what works for your family.

Insurance

It’s always a balancing act trying to work out the right amount of insurance to have. Higher premiums equal better coverage, but you may not necessarily need all that coverage. It’s worth talking to your partner (if you have one) and your insurance agent about your options. As a general rule of thumb, your personal (life, income protection, health) insurance premiums annually should be less than 10% of your annual income. Any higher than that is just over-insuring. For car insurance, the more expensive your car is, the higher the premiums. So you can save by not driving expensive cars!

Repeating outgoings

Repeating outgoings are things like gym memberships, Netflix subscriptions, Microsoft subscriptions and Afterpay repayments. Most of these things are wants, not needs. So if you’re looking to cut stuff, you can easily save a few hundred each month by cutting these out.

To start off, do up a forecast for the next six months. Monitor your results every month to ensure that you’re sticking to the plan. I have to keep emphasizing here that having a home accounting software will really help you in doing this well.

I’ve done everything I can but my cash flow is still negative!

Then we only have two options:

Explore financing options

Not the most ideal solution, however, you may realize that you just need a bit of money to cover your expenses over a short period of time. In this case, financing may be helpful. If you have equity in your own home, you can look at re-mortgageing your house. If you need finance for less than 30 days, credit card finance is usually interest-free if you repay within a certain period. Finally, most banks will provide an overdraft facility where you can only draw down on what you need. You get charged interest on any balance that is owed.

If you already have a lot of debt, then this may not be the best option for you.

Make more money

Again, not the most helpful suggestion but if you’ve done everything you can and your cash flow is still in a bad state, then your household needs more income. Consider starting a part-time job or running a small side hustle. If you own a business, think about ways to diversify your income stream. Our firm has a client who runs a bubble tea shop, laundromat and cleaning service all in one business. If one line of income isn’t working for you, try out another one.

Despite the overall gloom and doom in the economy, there are still opportunities out there. You just need to find them. Go and get them champ!

Always stay on top of taxes

There are different strategies to use for salaried workers and business owners.

PAYE salaried workers

If you’re on a PAYE salary, this one is really easy. Your employer pays taxes for you. At the end of the financial year, your taxes get filed. In most cases, you’ll end up with a nice refund. Note that this may not be the case if you’ve changed employers within the financial year. In fact, if you’ve switched employment within the financial year, it’s likely that your taxes are not being deducted sufficiently and you will have tax to pay at the end of the year.

Always review your tax position at the end of the financial year to make sure you don’t have any surprise tax bills to pay. If there are any tax bills to pay, make sure that you pay these ASAP. If you don’t have the cash on hand to pay your tax bills, you can always pay your tax debt in instalments. Most tax authorities will allow this, you just need to (yikes!) contact them and ask them to sort it out for you.

Business owners

There is a lot to know about business taxes and how they affect your personal taxes. So we’re not going to cover it all here. If you’re looking for tips on how to put aside money for taxes, you can read this article we wrote about paying yourself as a business owner.

For cash flow optimization, the best strategy is to pay taxes when they are due. This avoids interest and penalties on the outstanding amount. If you can’t afford to pay your taxes when they are due, there are two strategies you can use to manage your cash flow (please note that these tax strategies may only apply to Aotearoa New Zealand):

Paying on instalments

All types of tax debt can be paid in instalments. However, you will still be charged interest on overdue amounts, so this is not the best method to use if you’re looking at saving on taxes in the long term. Please note that your minimum repayment amount depends on the size of your tax debt. The larger the debt, the higher the repayment amounts.

Using tax pooling services

This only relates to provisional tax and income tax. You can purchase tax credits from an approved tax pooling agency which can then apply those credits to your your income tax balance for the previous financial year. The payments are credited on the due date of the tax payments — which means your penalties and interest on your tax debt get written off.

Obviously, you need to pay for this service. So instead of the tax department charging you an interest on what you owe them, the tax pooling agency will charge you interest on the tax credits that they ‘loaned’ to you. You can then pay the tax pooling agency as a lump sum or in instalments. Paying a tax pooling agency may be beneficial for the following reasons:

1. Tax pooling can be used after the due date for provisional and income tax
2. Interest charged by tax pooling agencies tends to be lower than tax charged by the IRD

Build out your cash forecast

Once you’ve attempted all of the above, you need to bring it all together in the form of a cash forecast. PocketSmith is really good in this regard as it automatically generates a projected bank balance based on your historical household spending. Of course this only works if you are updating your PocketSmith accounts regularly. So you should set aside at least one hour a month to match your bank transactions to the right categories.

If you’re trying to DIY your own forecast, you can use a spreadsheet. You need to identify your average monthly incomings less your average monthly outgoings. From there you can have a rough estimate of what your monthly baseline will be looking like. If you have any large, one-off expenses coming up, you can plug those figures into the months you expect them to be incurred.

For example: Chandran has already estimated that his household will have a monthly cash flow of $2,170. Chandran also knows that in two months’ time, he needs to pay his annual car insurance which costs $1,000. He makes sure that this is reflected in the forecast two months from now.

Setting your budget from your forecast

Once you have a forecast handy, you can build out a monthly budget based on your forecast. PocketSmith has a handy budgeting tool that allows you to set spending limits on different categories of expenses and income. This makes it easier for you to ensure that you are spending within budget.

If you’re not using a home accounting app, you can create different bank accounts that contain funds for different purposes. This is the modern ‘envelope budgeting system’. If you plan to spend $1,000 a month on groceries, you put $1,000 into the bank account for groceries and only use it for grocery purchases. Once the $1,000 is finished, you don’t buy any more groceries until next month.

Have a plan and stick to it

We’ve covered a lot in this article. Cash flow management is not easy! However, by practising the tips in this article, I’m confident that you will have a good idea of where to start optimizing your cash flow.

When it comes to household finances, you should always have a chat with your partner about the state of your finances. Identify areas of overspending. Talk about the sustainability of your income. Try and predict where your next major outgoing is going to come from. If you’re single, you can do this all on your own, or you could talk to a trusted person about it.

Use the tips in this article to come up with your own cash flow forecast and budget. To start off, do up a forecast for the next six months. Monitor your results every month to ensure that you’re sticking to the plan. I have to keep emphasizing here that having a home accounting software will really help you in doing this well.

I believe in you, dear reader. You can do this! Go on and optimize the heck out of your cash flow.

Stay positive!

Sam is the director of SH Advisory, an online accounting firm for small businesses and startups in NZ. He is also the creator of The Comic Accountant, an internationally-read finance comic blog. With 15 years experience in accounting and finance, he loves sharing quality financial advice with small business owners everywhere. In his spare time, he likes to nerd out over the latest board game launches and great PC gaming deals online. If you need help with your small business and startup, Sam is the person you want to talk to!