Cash flow is the lifeblood of every small business but many
business owners underestimate just how vital managing cash
flow is to their business's success.
In fact, a healthy
cash flow is more important than your business's ability to
deliver its goods and services.
While that might seem counterintuitive, consider this: if you
fail to satisfy a customer and lose that customer's business,
you can always work harder to please the next customer.
fail to have enough cash to pay your suppliers, creditors, or
employees, you are out of business.
What is Cash Flow?
Cash flow, simply defined, is the movement of money in and out
of your business; these movements are called inflow and
outflow. Inflows for your business primarily come from the
sale of goods or services to your customers but keep in mind
that inflow only occurs when you make a cash sale or collect
on receivables. It is the cash that counts! Other examples of
cash inflows are borrowed funds, income derived from sales of
assets, and investment income from interest.
Outflows for your business are generally the result of paying
expenses. Examples of cash outflows include paying employee
wages, purchasing inventory or raw materials, purchasing fixed
assets, operating costs, paying back loans, and paying taxes.
Note: A tax and accounting professional is the
best person to help you learn how your cash flow
statement works. He or she can prepare your cash flow
statement and explain where the numbers come from. If
you need help, don't hesitate to call.
Cash Flow versus Profit
While they might seem similar, profit and cash flow are two
entirely different concepts, each with entirely different
results. The concept of profit is somewhat broad and only
looks at income and expenses over a certain period, say a
fiscal quarter. Profit is a useful figure for calculating your
taxes and reporting to the IRS.
Cash flow, on the other hand, is a more dynamic tool focusing
on the day-to-day operations of a business owner. It is
concerned with the movement of money in and out of a business.
But more important, it is concerned with the times at which
the movement of the money takes place.
In theory, even profitable companies can go bankrupt. It would
take a lot of negligence and total disregard for cash flow,
but it is possible. Consider how the difference between profit
and cash flow relate to your business.
Example: If your retail business bought a $1,000
item and turned around to sell it for $2,000, then you
have made a $1,000 profit. But what if the buyer of the
item is slow to pay his or her bill, and six months pass
before you collect on the account? Your retail business
may still show a profit, but what about the bills it has
to pay during that six-month period? You may not have
the cash to pay the bills despite the profits you earned
on the sale. Furthermore, this cash flow gap may cause
you to miss other profit opportunities, damage your
credit rating, and force you to take out loans and
create debt. If this mistake is repeated enough times,
you may go bankrupt.
Analyzing your Cash Flow
The sooner you learn how to manage your cash flow, the better
your chances of survival. Furthermore, you will be able to
protect your company's short-term reputation as well as
position it for long-term success.
The first step toward taking control of your company's cash
flow is to analyze the components that affect the timing of
your cash inflows and outflows. A thorough analysis of these
components will reveal problem areas that lead to cash flow
gaps in your business. Narrowing, or even closing, these gaps
is the key to cash flow management.
Some of the 5 most important components to examine are:
Accounts receivable. Accounts receivable represent sales that
have not yet been collected in the form of cash. An accounts
receivable balance sheet is created when you sell something to
a customer in return for his or her promise to pay at a later
date. The longer it takes for your customers to pay on their
accounts, the more negative the effect on your cash flow.
terms. Credit terms are the time limits you set for your
customers' promise to pay for their purchases. Credit terms
affect the timing of your cash inflows. A simple way to
improve cash flow is to get customers to pay their bills more
policy. A credit policy is the blueprint you use when
deciding to extend credit to a customer. The correct credit
policy - neither too strict nor too generous - is crucial for
a healthy cash flow.
Inventory describes the extra merchandise or supplies your
business keeps on hand to meet the demands of customers. An
excessive amount of inventory hurts your cash flow by using up
money that could be used for other cash outflows. Too many
business owners buy inventory based on hopes and dreams
instead of what they can realistically sell. Keep your
inventory as low as possible.
payable and cash flow. Accounts payable are amounts you
owe to your suppliers that are payable at some point in the
near future - "near" meaning 30 to 90 days. Without payables
and trade credit, you'd have to pay for all goods and services
at the time you purchase them. For optimum cash flow
management, examine your payables schedule.
Some cash flow gaps are created intentionally. For example, a
business may purchase extra inventory to take advantage of
quantity discounts, accelerate cash outflows to take advantage
of significant trade discounts or spend extra cash to expand
its line of business.
For other businesses, cash flow gaps are unavoidable. Take,
for example, a company that experiences seasonal fluctuations
in its line of business. This business may normally have cash
flow gaps during its slow season and then later fill the gaps
with cash surpluses from the peak part of its season. Cash
flow gaps are often filled by external financing sources.
Revolving lines of credit, bank loans, and trade credit are
just a few of the external financing options available that
you may want to discuss with us.
Monitoring and managing your cash flow is important for the
vitality of your business. The first signs of financial woe
appear in your cash flow statement, giving you time to
recognize a forthcoming problem and plan a strategy to deal
with it. Furthermore, with periodic cash flow analysis, you
can head off those unpleasant financial glitches by
recognizing which aspects of your business have the potential
to cause cash flow gaps.
Make sure your business has adequate funds to cover
If you need help analyzing and managing your cash flow more
effectively, please call. Help is just a phone call
Understanding cash flow can be difficult and complicated.
If you need help or have a question, as always please contact
us here at the office.
Don't hesitate to call us if you need help or
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