What is cash flow?
Cash flow is one of the most essential part of one’s business – It is the money, which comes in & goes out from the business sources, in simple words, generation of income and the payment of expenses.
For Example: Payments from customers, interest on savings or investments, employee salary, etc.
There are 2 types of cash flow analyses.
- Positive cash flow: This happens when your business is running smoothly – when the inflow of cash is more into your business from sales, account receivables from customers or clients, more than the amount of cash goes from your business through account payables, monthly expenses like employee salaries, rent, bills, credit card payments,
- Negative cash flow: This happens when your outflow of cash is more than your cash inflow. This does not necessarily mean cash loss, considering the income that could be in the future. It represents mismatch of expenses and income.
The above basic analysis would let you understand the inflow and outflow of cash in the business and analyse whether the earnings are more than the expenses or vice versa.
In many businesses when there is a negative cash flow, it indicates that the business expenditures are more than its earnings. Then you must take certain steps to fix the negative cash flow problem and get into positive zone.
How you do it?
- Prepare a list of all possible customer payments for that month and in future dates, any interest or dividend gains, etc. Estimate the probable amount of incoming cash.
- Prepare a list of all expenditures such as employee salary, supplier payments, rent, and other possible office expenses. Estimate the monthly expenses to know the outgoing cash.
- If your analysis shows a positive cash flow you are in a win situation but if it is a negative cash flow, alas, you are in trouble.
Cash flow history will guide you in such conditions. An analysis of cash flow history will let you to be prepared yourself for less cash in hand situations. You set up a sufficient cash reserve for such months which will get you out of such a glitch.
A quick and easy way to perform a cash flow analysis is to measure the overall due purchases to the total sales due at the end of each month. If the total unpaid purchases are greater than the total sales due, you’ll need to invest more cash than what you are going to receive in the next month, indicating a potential cash flow problem.
“Why cash flow is more important than profit”
Profit; refers to improvement. It does not really mean more money on hand. Profit is the revenue after all expenses deducted from your income. It is the all-inclusive general figure of a business, and it is the part of cash you expect to make over a given period of time.
At the same time cash is the thing that you should have on your hand to keep your business running smoothly. After some time, an organization’s profit has little value if they are not lead by positive net cash flow. You can’t spend profit but you can just spend money or cash.
Cash flow; refers to the development of inflow and outflow of money of a business and it is important task for any business to manage a well balanced cash flow. It is required for day to day working operations like purchasing, inventory, salary for employees, taxes, and other operating costs.
How important is Cash Flow?
When it comes to small business management, small businesses keep running on money and knowing where money is and where it’s gone is among the most critical things an entrepreneur should know. Many business owners or CEOs of organizations do not know the value of cash flow its importance. Cash flow gives a definite idea of overall growth and strategy of the business.
In many cases, when you invest money or cash somewhere or in a new business which generates profit for the company, every business owner’s primary target is customers. When you take decisions as a business owner or CEO to develop the business, first you require a perspective of the effect of cash flow.
One of the biggest mistakes many business owners do is they look at their profit and loss statement to check the cash position. They think we’re making profit; instead they should refer their Cash flow statement.
Few ways to understand the cash flow so you deal with your business smoothly.
- What is your current available cash balance?
- What you can expect from your cash balance? Down the line after 5 to 6 months from now!
- If you have finance department or CFO in your company then sit and discuss with them, what “solid set of books” you have? And how transactions are happening?
Keep a check on transaction records they have maintained for last 4 to 6 months or 3 months. So that you can plan for the new business cash flow. Or set the goal for new project cash flow.
“The above 3 points are just not for your year budget. We are avoiding risks of cash flow for new business management.”
Make sure that you never run out of cash – No matter what it takes! This might lead to difficult discussions but if you run out of cash, you won’t have a business. Carefully understand the importance of cash flow.
Primary driver of cash flow is Profit and Loss; understand the difference between Revenue and Expenses, Capital Expenditures, Debt service or other investments in the company, account receivables, estimated taxes and account payables.
When you are working on cash flow take an account of your customers invoices paid on credit period based on number of days like, 15 days, 30 days, 60 days, 90 days and also track the same credit note and debit note . Take note on all these terms to maintain proper cash flow. This will help to make monthly expenses like, rent, salaries, bills and etc.
Always cross check what is your cash balance; it will help you to handle situations, even if you are running with cash shortage, at-least you can plan for how not to go cashless.
Focus on priority of the business, cash flow, not profit- even profitable businesses will go burst, if you don’t keep eyes on your cash flow all the time.
Even if you have a consistent cash flow, it is difficult to say that when the cash stops coming into the business. So to avoid this you ask few questions to yourself –
- Where do you expect your cash flow balance after 5 to 6 months from now?
- Is this what you have achieved? Or
- Where you want to be?
This is just to avoid possibility of biggest mistake what people might make. Foresee the problem rather than wait until the cash flow problem lands on your doorsteps.
“Understand how you can generate cash in your business”
Identify the source of inward cash flow and concentrate on how you can expand more to generate more cash. So your mission in life is to make your business generate as much as cash inflow, that’s how you gain rewards in the business.
Plan your cash flow every quarter or 6 months prior, based on that where you can recruit the staff and keep business in the future is essential and be friendly with your customer & deliver excellent service.
“For every business, the cash flowing into a company is essential for covering the everyday expenses necessary to run a business. It keeps lights on and doors open; cash flow is truly the quality of a business. Unfortunately, it’s not uncommon that companies of all shapes and sizes have to slow down business growth due to lack of cash flow needed for expansion”