Managing cash flow is one of the critical aspects of business success and survival. As much as 82% of businesses crash and burn because of poor cash flow management. The smaller the business, the more crucial and challenging it is to maintain a steady income and pay the bills on time.
But what exactly is cash flow, and why is there so much talk about cash flow management when it comes to business? Let’s go through some basic concepts, understand how it affects our businesses, and find out solutions to improve cash flow.
Understanding Cash Flow
Cash flow is the movement of cash into or out of an account. This is known as the inflow or outflow of cash in a business organization. When more money is coming in through the sale of goods or services than the actual cost of running a business, it is said to be cash flow positive; cash flow negative if it’s the other way around.
Businesses will experience cash flow positives and negatives throughout their lifetime. Start-ups are the most difficult to manage for having low cash reserves and susceptibility to undercapitalization. However, they’ll have better opportunities to accelerate their business through loans, stocks, or bonds after demonstrating their ability to handle cash flow properly (known as cash flow statement).
Operational cash flow is the movement of cash during its regular business activities, e.g. receiving payments from customers, settling monthly dues, and paying out employees. Investment cash flow applies when a business acquires properties to further its goals. For instance, acquiring a vehicle through a financial institution can help boost inflow by speeding up delivery and reducing logistical cost.
Difference between Profit and Cash Flow
Some financial experts use the metaphor of looking at a still photo and watching videos clip to differentiate profit and cash flow. Profit is usually regarded as stationary data, which is determined by comparing the opening and closing balance of a company’s primary account or by its total net worth by the end of the year.
Cash flow provides a better picture of how businesses performed over the course of time. It tells us where the money is coming from, where it’s going to, and most importantly how fast. Without cash flowing in and out of the business, the whole system will come to a grinding halt. All gains in the form of assets, products, or inventories are of little consequence at this point. Having no cash to work with, businesses are on the verge of bankruptcy.
In other words, a company can increase its net worth but may actually lose the business if it doesn’t generate inflow through sales, and utilize these resources to pay the right people working for the company and acquire the best technology to improve business.
How Cash Flow Affects Your Business
Managing cash flow can be a tough balancing act for small business owners. Increasing inflow and keeping outflow at a minimum on a shoestring budget is especially challenging for small business owners.
Consider the following aspects of cash flow management:
Cost of running a business. The initial cost of starting a business is just a tiny part compared to the actual cost of running it. People can get this information through research and interviews with successful business owners. Operational costs make up the outflow including lease, water and electricity bills, fuel and maintenance, inventories, employees’ salaries and commissions, monthly amortizations, taxes, insurance, contingencies, penalties, and surcharges (if you’re not careful), and the list goes on. Expenses are either fixed or fluctuating. Some experts suggest putting a little extra and exaggerate the cost at the planning stage. The purpose is not to deter you from starting your own business, but to prepare yourself mentally and financially for eventualities. Running out of cash and borrowing only when you needed one sets you up for business failure.
Real and potential income. How much money can you realistically make with your business? Some businesses, especially new ones, can be overly optimistic and assume they can strike it rich too quickly. We need to consider other factors as well, such as the competition, supply and demand, sustainability, market value, what the trends are and where they’re headed for, and so on. Unlike the previous one, we need to be a little conservative on this. We cannot expect our chosen industry to follow the same trend all throughout the year. Our businesses should be flexible enough to adapt to changes. If the demand for a certain product or service drops, what are your other options? Do you have a method in place that allows you to get more customers and build relationships with them? The key is to maintain a specific number of customers to keep the ball rolling in order to stay in business.
Method of payment. Your business may receive payments either on a cash basis or receivables on a weekly or monthly basis – or you may have both. Cash-based transactions allow businesses to have a steady inflow of cash, whereas receivables carry some risks due to some customers not settling their dues or paying too late, costing a lot of money to your company. You can mitigate the risk by imposing penalties for late payment or encouraging them to pay early by offering rebates and discounts for settling their dues early on. Just keep in mind that any delay with the cash will cost you money. If your business needs to pay out employees on the 25th of the month and you still have a lot of receivables unpaid, you might have to borrow on interest just to get your employee’s paid (this justifies why you need to penalize late payments).
Steps to Improve Cash Flow
With these in mind, let’s look at some of the ways to improve cash flow in your business.
- Forecast your cash flow. From your research and interviews with business owners create a chart of your projected inflows and outflows for the whole year. Make sure to include all the small details and make it as comprehensive as possible. Use this to benchmark your progress when conducting your business.
- Identify your key performance indicators (KPI). This answers the question where most of your resources should go to keep your business running. Some businesses failed just because they didn’t use their resources on things that would help improve its overall performance. For instance, not having enough inventories to cater a large number of customers or not investing in technology or equipment to speed up delivery and enhance customer experience will have consequences in your cash inflow.
- Manage your inventories. Too much, or too little, can make your business cash flow negative over time. You need to be able to predict customer orders to keep a steady flow of cash going into your business, but at the same time, we want to avoid excess or unwanted inventories sitting on the shelf for too long.
- Faster inflow, slower outflow. Perhaps the most important principle when it comes to cash flow management is speeding up the inflow of cash and slowing down the outflow. To increase inflow, obviously you need more customers. But more importantly, you need to develop good customer relationships, and have a loyal customer base to keep the money flowing in. Customer referrals from loyal customers could increase the inflow even more, which is why we put a strong emphasis on customer relationships with our Small Business Dream mini-CRM. To minimize outflow, you’ll just have to keep the money in your primary account for as long as you can. If you have to invest in technology, property, or equipment, acquire them through a financial institution instead of paying out in cash. The longer the amortization period, the smaller your monthly dues are, and the bigger your potential inflow will be.
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