Cash flow is the total amount of money coming in and out of your business. A positive cash flow enables smooth day-to-day operations, improves investment opportunities, and helps your business grow.
This article tells you more about cash flow management and its relevance to your business. We cover the following points:
- What is cash flow, and why does it matter?
- Why should small business owners track cash flows?
- How do you manage cash flows?
- What to do next?
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What is Cash Flow and Why Does it Matter?
Cash flow is the actual money coming in or going out of your business. Positive cash flow means more cash is coming into the business than leaving it while negative cash flow implies the opposite.
It doesn’t only refer to sales and expenses. For instance, even taking a loan means cash coming into the business while repaying a loan means money flowing out of the company. So, sales revenue is a part of your business’s cash inflows, but it’s not the only source.
Why Is Cash Flow Important?
Cash flow is vital because it represents your business’s financial health and amount of liquid assets. Sufficient cash flow is needed to meet essential business needs, such as purchasing raw materials, payroll, covering overhead costs, and repaying lenders. Here are some other reasons why cash flow is important:
- It gives you insight into your spending activity beyond what’s presented on your profit and loss statement.
- Positive cash flow ensures you have enough money to repay loans and pay suppliers, helping you build better professional relationships.
- Since cash flow statements provide a detailed account of how much cash your business has on hand, they also help with financial projections and decision-making.
It’s important to keep track of your cash flow as it indicates your business’s financial health. However, maintaining consistent, positive cash flow isn’t easy, and many entrepreneurs struggle with it. Most small businesses fail due to a poor understanding of cash flow and cash flow management.
How Does Cash Flow Impact Your Small Business?
Managing cash flows can impact business prospects in many ways:
- Small businesses often buy goods from suppliers on credit. If you regularly default on your payments, it would affect your relationship with the supplier adversely.
- Similarly, banks and other financial institutions lend money for working capital, capital purchases, and expansion. If loans aren’t repaid, your credit score is impacted negatively and raising future financing becomes difficult. Building a good credit score is crucial for borrowing.
- Managing cash flows is crucial for getting a holistic picture of your small business. Strong cash flows reflect customers are making payments.
- Let’s say Company A and B have the same profit. One may have money in the bank, while the other may have mostly accrued profit (due to credit sales). Company A may seem more reliable to lenders since cash is coming in.
- Maintaining an updated cash flow statement can show you where cash is going and help you reduce unnecessary expenditures.
- Cash flow is vital for expansion and growth. Scaling operations requires purchasing assets like buildings, machinery, computers, hiring employees, and developing a marketing campaign. Monitoring your cash flow regularly enables you to make more accurate projections and understand the right time to scale your business.
How Do You Manage Cash Flows?
- Stay on top of your receivables
- Be smart about your payables
- Negotiate terms with suppliers or vendors
- Get inventory off the shelf
- Maintain accounts diligently
- Consider financing options
- Use quality payment software
There are several ways small business owners can improve cash flow management and ensure that a healthy amount of cash is circulating in the business at any point. Some of these are outlined below.
Stay on Top of Your Receivables
Businesses often sell their goods or services to customers on credit and receive the payment within 30 to 60 days. While some responsible customers pay before time, others pay consistently on the 58th or 59th day or maybe even later.
You should track your accounts receivable and send customers follow-ups and reminders close to the due date. If customers default, a late penalty or interest charge could be imposed. You can also ask for upfront deposits from customers and offer discounts to those who pay quickly.
Be Smart About Payables
Cash flow increases when cash is received quickly and accounts payable (A/P) is low or delayed as much as possible. You can sort payments and bills according to priority to better manage your cash flow. For example, important bills can be paid earlier while smaller accounts can be paid closer to their due date.
It’s good practice to time cash flows and expenses strategically. However, this doesn’t mean you should delay payments beyond their due date and risk ruining your credit standing.
Negotiate Terms With Suppliers and Vendors
If you find yourself with a high accounts receivable balance, consider negotiating a longer credit period with your suppliers to maintain a steady cash flow. It always helps to compare vendor and customer payment terms to determine when cash is coming in and going out.
Asking for longer credit periods is highly dependent on your relationship with suppliers and vendors. Your suppliers are more likely to allow flexibility in your payment terms if you usually make timely payments.
Get Inventory Off the Shelf
A buffer stock of inventory always helps, especially during periods of high demand. However, if inventory cannot be moved and remains on the shelf, it could harm your business. More inventory means less cash in hand. Further, if the items in inventory are perishable, they may surpass their expiration date if they’re not sold soon.
Measures like the inventory turnover ratio ― cost of goods sold (COGS) divided by average inventory ― help you understand how quickly inventory is being sold. Several startups use inventory management software to ensure stock is being purchased and sold efficiently.
Maintain Accounts Diligently
Your firm’s cash flow statement is the best indicator of where money is coming in and where it’s going. Update the cash flow statement regularly and analyze all sections to determine where the business can utilize cash more efficiently.
Consider Financing Options
Financing can help achieve short-term and long-term objectives while leaving existing cash untouched. As a small business owner, you should consider asking your bank for a business credit card. Banks often offer reward systems and cashback offers on some cards, so keep an eye out. You can use this credit card to pay for small bills and everyday expenses. Disciplined usage of the card can also help you improve your credit score.
Other financing options include lines of credit and cash flow loans. A cash flow loan is typically short-term and has a high-interest rate. These loans should ideally be used to fund activities that help your business grow, such as a new advertisement or buying a high-quality machine. But first, you should conduct a cost-benefit analysis to see if a cash flow loan is worth it. In contrast, you can use a line of credit to purchase equipment and raw materials or for unforeseen expenses.
Use Quality Payment Software
It’s no surprise that technology helps speed up and simplify several business processes, so why not apply it to your cash flow planning? Well-designed billing and invoicing software can ensure that your payments are made and received quickly and conveniently, giving you more time to focus on other aspects of running your small business.
What To Do Next?
As a small business owner, your next step should be to leverage your cash flow statements to identify areas in your business where cash can be better managed.
- Talk to your accountants or financial advisors to get a clearer picture of your cash flows
- Review payment terms with suppliers, vendors, and customers
- Implement cash flow management software to automate parts of the process, minimize errors, save time, and improve cash circulation
- Ask your bank for the available financing options. These could include working capital finance, credit cards, cash flow loans, or lines of credit
In times of uncertainty and market stress, small businesses suffer more than large companies due to inexperienced management skills, limited product mix, and fewer resources. However, effective cash flow management can help you forecast and prepare for the best- and worst-case scenarios. It can also differentiate your small business from competitors and help you stay ahead.