Why Is Cash Flow Important?
Your business plan is all laid out, you know how your startup costs are going to be covered, and you’re ready to flip the switch and get things moving. But wait! Have you performed a thorough cash-flow analysis? If not, don’t be so quick to sign the office lease or hire those employees. You need to learn to understand cash flow or your business will run about as well as an engine without oil.
What Is Cash Flow?
Experts agree that a properly managed cash flow is one of the most important factors in a successful small business. So what does that mean? Here’s a hint: it’s not your profitability. Cash flow describes the movement of cash in and out of your business. Cash inflows are any activities that increase your company’s cash, such as selling inventory, issuing and selling stock and taking out loans. Cash outflows include purchasing inventory, paying off loans and paying wages. As you’ll learn in a moment, the timing of cash flows is key.
Why Is Cash Flow Important?
If you can’t pay a supplier on time, it won’t matter how positive your projections look or how profitable you were last month. They may choose only to sell to you at a steep premium from then on, or worse: they may refuse to do business with you again at all.
Imagine, for a moment, that you run a profitable business importing widgets and selling them to a few local shops. Each shipment will cost you $5,000, and your total revenue from selling them will be $7,500 ¾ a tidy profit of $2,500. The catch? Payment is due within a week of receiving the shipment, but your sales process takes two weeks and payments require one more. In the meantime, you need to come up with that $5,000 ¾ either from last month’s revenue or a loan.
How Can I Manage Cash Flow?
A cash budget is a tool used to analyze the availability of cash over the course of your operation. For each period, you tally up your beginning cash for the period, cash inflows and cash outflows. The total is your “ending cash” that will be available to carry over to the next period. If you see a deficit, you know you need to find a way to adjust the timing, size or number of your cash flows until everything is positive. However, if your ending balance is always positive and tends to grow over time, it means you should be expanding!
If you don’t know how to set up a cash budget, just do a quick online search for “cash budget template.” Remember though, you know your business better than a template does. Make sure the cash inflows and outflows match up with your operation.
Cash budgets often use quarterly, monthly or weekly periods. However, if you’re just getting started or your business is having financial trouble, it might be a good idea to get into the nitty-gritty and project your cash flows for every day for a few weeks of operation. Then, keep track of your actual cash flows every day and compare. With this information, making a sound decision to improve your enterprise will be easy.
Understanding how to perform cash-flow analysis is a huge step toward managing a successful business. If you had never heard of it before, that’s okay! Now you’re ready to put your knowledge to work.