Why is cash flow important to a business? This tends to cross the mind a lot especially when you need to start up or run your business. Running a business is never without challenges.
There are different components involved in running a business, and different components that have to be managed to ensure its success. One such component is the cash flow.
Upon first glance, cash flows seem quite easy to understand.
It’s all about the flow of money, the cash; what goes in and out of the business.
Usually, collections are generated via sales while outflows result from expenditures.
But there’s more to the concept of business cash flow than this simple explanation of an inflow and outflow of cash.
Here’s something that can help you gain a better understanding of the cash flow process.
Business Cash Flow In A Nutshell
Understanding the concept of business cash flow may not be simple, especially if you are a new business owner.
Well, the cash flow of a business is important because it gives you a measurement of how much money the business generates and how much it spends.
Right from the get-go, it gives you a reasonable measure of performance and liquidity.
You can pretty much compare the cash flow of a business to a water tank.
A water tank rarely keeps its collection for long.
Water is collected from up top and is drained through the bottom as often as the owner sees fit.
But the objective here is to keep the tank full rather than empty.
You want to have more water coming in rather than leaking out.
The same goes with cash.
It’s important that you understand how the inflow and outflow of cash works.
But first, you have to know what these two cash flow activities are.
The cash inflow is your business’ lifeblood.
It covers everything that drives money to your company; from payments, loan receipts, investments, savings interest, to external funding or financing.
Understanding this internal flow of money is important because it will give you an idea of how much you have, and can use to pay for things that your business needs to continue running.
Examples of regular expenditures that make up cash outflows include raw or stock materials, overhead components like manpower, rent, and so on and so forth; basically, your operating expenses.
This is why you need to ensure that you maintain a positive internal cash flow.
By having a positive cash flow balance, it means that your business is operating seamlessly.
The higher this inflow, the better, and the more opportunities you have of enhancing your investments and improving your operations.
With enough cash, you can stock up, hire more people if needed, or even open a new location for your business.
Your cash flow will determine whether or not you can grow the business right now.
But you should know that as a business owner, you also have to acquaint yourself with the possibility of a negative cash flow.
In this case, there’s more money going out instead of coming in.
This isn’t necessarily bad, especially during the first stage in the business.
It’s just not the kind of scenario that you should be maintaining.
The objective is always to generate a positive inflow.
It would be better if you achieved this early on and managed it so that it doesn’t turn negative.
Understanding the Importance of Cash Flow
At some point in your business operations, you’ll come by something known as a cash flow statement.
So apart from learning how to calculate the cash flow and how to prepare a cash flow statement, it’s also crucial that you gain an understanding of a cash flow statement.
This document doesn’t merely indicate your cash flow activities within a certain period of time.
The cash flow statement isn’t merely there to show you your bottom line; the cash flow balance.
It helps you learn how to manage cash flow by clarifying where your money comes from and goes to.
As you go through the document, you can see where you’re spending most on and identify any areas that can be improved upon.
You can determine other potential sources of cash or opportunities where you can generate more cash from the same activities you’ve been engaging in.
You can also determine areas of the business that you can re-evaluate for the purpose of potentially reducing cash expenditures.
Maybe you’ve been spending a lot on manpower or stocks.
As you see it clearer in black and white, you might be encouraged to re-assess the situation and cut back on a few things thereby saving you cash for other uses.
Cash Flow Matters because..
Well, the cash flow figures show you the net change in your cash inflows and outflows from period to period. It gives you a good gauge on your business’ current cash position.
As such, you’ll have an idea of where you’re generating cash and where you’re spending said earning.
As previously mentioned, more cash flowing into the business means that you have a positive inflow.
It can also mean that you have more inflows compared to outflows or expenses.
By this, it’s considered to be a reliable indicator of your business’ financial health.
Here are four reasons why cash flow matters:
Cash Is King
You’ve probably heard this phrase several times before but yes, cash is indeed king.
This is because it’s highly liquid compared to other assets that your business may have.
Having cash on hand puts you in a far better position, offers stability, and grants you better purchasing power.
Although you can borrow money most of the time, cash offers the kind of protection against loan defaults that no other monetary element can.
It protects you from having to worry about angry debtors and foreclosures.
But you have to understand that the concept of cash flows and cash position are different.
It’s always best that you have cash on hand but your ability to consistently generate and use cash is even better.
It Helps With Debt Management
Given that there are times when you’ll have to borrow money for your business, it’s your expected cash flow that helps you manage and schedule payments.
It’s important that you expect a positive inflow and balance to keep up with your obligations.
For most companies, the strategy that they use involves long-term and short-term loans.
Each of these requires payments every month and these payments limit what you can do with your free cash flow.
But nevertheless, knowing that there are loans to be paid helps you make wiser decisions when it comes to your cash usage.
It Helps With Business Growth
Just like how it helps you manage debts better, your cash flow also opens up opportunities for you to grow your business; be it adding personnel, stocking up, or opening new outlets.
It gives you flexibility in investment with a reduced need to spend on interest payments.
As such, you can do more with every dollar.
There are so many things that you can do when your cash flows are desirable.
You can spend on research and development, renovate, train staff, improve your tech, and so on and so forth.
You can engage in numerous activities that can help you grow your business and improve your cash inflows even more.
Also, the great thing about having excess cash is that you can carefully and critically think about every decision you’ll be making.
Your actions will definitely be more proactive than defensive or reactive.
It Gives You Operational Flexibility
With enough cash, you can also address emergencies and dilemmas with ease.
Making critical decisions will be easier than usual as you’re confident in your assets and liquidity.
Also, instead of having to wait or pass up certain opportunities, you can jump right in and reap its rewards in a jiffy.
When it comes to sourcing funds, being cash-stable makes you a worthwhile investment for banks and the like.
This means that getting a loan or attracting investors will be easier for you to achieve.
When it comes to financing, you can also expect to be granted favorable terms of credit.
How To Manage Cash Flow
We’ve talked about expected cash flow, the need to learn how to prepare a cash flow statement, and understanding a cash flow statement.
But it’s also important that you learn how to manage these cash inflows and outflows because just learning how to calculate the cash flow won’t cut it.
Here’s how you do it.
Just like with the other responsibilities that you have to attend to as a business owner, it’s important that you be as organized as possible.
Being organized helps you act in a timely manner, make correct decisions, and ensure that you don’t miss out on anything important.
When it comes to your cash flows, you have to set a baseline.
In this case, take a look at whatever cash amount you have on hand.
Consider your business investments, money in your bank account, loan proceeds, and the like; anything liquid that you can spend when needed.
After this, assess your obligations. See how much you’re spending (fixed) on a monthly basis.
This will cover loan payments, overheads, and operational expenses.
Also, take into consideration monthly allowances for miscellaneous needs.
List everything down so that nothing is forgotten.
In this case, it would be better if you weren’t as conservative with the valuation.
This is so that you’ll have enough room to move in just in case figures change for these expenses.
Once you’ve listed everything down, inflows and outflows, create a spending blueprint.
Just like how you created a business plan earlier on, develop one for your cash usage too.
This will help you address all obligations and balance inflows and outflows with ease.
Make sure that you plan everything, miscellaneous expenses included.
Also, take into consideration the possibility of lean days or months. It would be ideal if you did some groundwork here.
Do your research when it comes to industry and market trends.
Take a look at your own business’ data on past sales and expenses.
There’s much value to be gained in spending the time collecting these data.
This is because doing so will be helpful as you draft your plan.
See how much you need to spend every month on fixed costs then create contingency buffers for possible costs you might incur.
It’ll be a good idea to create allowances for repairs as well.
Now that you have a plan, you can forecast how much money you need to generate to ensure a positive balance every month.
Additionally, business environments change, consumer-spending habits change, and the like.
So, create a workable plan that you can adjust as you deem fit.
Generating cash from sales and investments is not the only thing that you should concern yourself with.
At some point in your business, you’ll have to deal with receivables from clients.
In this case, you have to see to it that you get paid as soon as possible; and with the least amount of hassle of course.
The thing about invoicing customers is that it may seem simple but if you’re working with a liberal repayment schedule, it can make planning your monthly cash flows quite tricky.
What you have to do is encourage your customers to pay quickly.
Here’s what you can do;
Make sure that you always issue invoices promptly.
As much as possible, follow up on your collections.
Don’t hesitate to do so.
But remember to be as respectful as possible when you do this.
Encourage your customers to pay earlier.
You can offer discounts for payments made early.
Now, this can come in the form of a cash discount, say a small percentage off of the bill for paying within 10 instead of 30 days.
You can also offer discounts or special deals for future orders.
This way, you can secure more business to come your way.
If you deliver projects to clients, you can also work with payment structuring.
In this case, you can issue a deposit requirement as the first payment then schedule fixed weekly or monthly payments moving forward; this will depend on how lengthy the project is.
This way, you’re assured of a certain amount within a certain period.
Although you want receivables to be collected in the soonest possible time, if the tables are turned, then you want to max out payment schedules to the last couple of days before your invoice expires.
Since cash is king, you want to hold onto it for as long as possible.
If you can legally hold payments to the last couple of days as stated on the invoice issued to you, by all means, do so.
Use these terms to your advantage.
But if there are discounts offered by suppliers, for example, in exchange for early payment, then see if the discount is worth you making the payment before the collection period lapses.
You can also set up electronic transfers so that once due dates arrive, your invoices will automatically be paid for through bank transfers.
This will help you reduce the onset of late payments and penalties simply because you forgot.
Prior to making any purchase, you can also ask about payment terms and see how flexible they can be.
You can make deals with your suppliers in this case.
But remember to play it by ear.
In some cases, if you ask for flexible payment terms before making a purchase, a supplier might see it as a red flag and refuse to do business with you.
As much as possible, build a relationship with your suppliers.
Be honest with them and never take advantage of their trust.
The more trustworthy you are, the more they’re likely to accommodate your requests for extended terms in good faith.
In every business, there are lean months.
This is dependent on the industry, your product or service, and consumer habits.
You can get a better gauge of it by looking at trends and assessing your past months’ performances.
The thing about lean months is that they are applicable to inflows, not expenses.
More often than not, you’ll still have to settle monthly overheads and the like even if your business generates sales that are too small to account for.
This is why you need to set up buffers or cash reserves to help you survive these low points.
Depending on your fixed costs and allowance for miscellaneous expenses, create a cash fund that can last you anywhere from 3 to 6 months.
In this case, carefully calculate your costs.
Creating too small of a buffer fund won’t help and creating an excessively large pool will limit your free cash flow usage.
Another option you can go with is to arrange a line of credit with your preferred financial institution.
This way, you’ll have immediate access to funds when needed without having to store much of your cash in a vault.
The availability or lack of it or cashflow can build or break your business.
Keep on top of it to increase your chances of being successful in business.
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