| Cash Flow -- The Pulse Of Your Business
||There are frighteningly many small business owners out
there who do not understand their cash flow statement. A shocking fact
considering that all businesses essentially runs on cash. And Cash flow is the
life-blood of your business. Some business experts go so far as to say a healthy
cash flow is even more important than your business’s ability to deliver its
goods and services! You may find that perspective hard to swallow, but consider
this – if you fail to satisfy a customer and lose that customer’s business, you
can always work harder to please the next customer. But if you fail to have
enough cash to pay your suppliers, creditors, or your employees, you’re out of
What Is Cash Flow?
||Cash flow, simply defined, is the movement of money in and
out of your business; these movements are called inflow and outflow
respectively. Inflows for your business primarily come from the sale of goods or
services to your customers. The inflow only occurs when you make a cash sale or
collect on receivables, however. Remember, it is the cash that counts! Other
examples of cash inflow are borrowed funds, income derived from sales of assets,
and investment income from interest.
Outflows for your business are generally the result of
paying expenses. Examples of cash outflow are…paying employee wages, purchasing
inventory or raw materials, purchasing fixed assets, operating costs, paying
back loans, and paying taxes. Your accountant is the best person to help you
learn how your cash flow statement works. At your annual review or audit, make
sure your accountant explains where the numbers come from in your cash flow
|Cash Flow Verses Profit
||Profit and Cash flow are two entirely different concepts,
each with entirely different results. The concept of profit is somewhat broad
and only looks at income and expenses over a certain period of time, say a
fiscal quarter. Profit is a useful figure for calculating your taxes and
reporting to the IRS.
Cash flow, on the other hand, is a more dynamic tool
focusing on the day-to-day operations of a business owner. It is concerned with
the movement of money in and out of a business. But more importantly, it is
concerned with the times at which the movement of the money takes place.
Theoretically even profitable companies can go bankrupt.
It would take a lot of negligence and total disregard for cash flow, but it is
possible. Consider how the difference between profit and cash flow relate to
your business. For example, if your retail business bought a $1000 item and
turned around to sell it for $2000, then you have made a $1000 profit. But what
if the buyer of the item is slow to pay his or her bill, and six months pass
before you collect on the account? Your retail business may still show a profit,
but what about the bills it has to pay during that six-month period? You may not
have the cash to pay the bills despite the profits you earned on the sale.
Furthermore this cash flow gap may cause you to miss other profit opportunities,
damage your credit rating, and force you to take out loans and create debt. If
this mistake is repeated enough times you may even go bankrupt!
|Analyzing Your Cash Flow
||The sooner you learn how to manage your cash flow, the
better your chances for survival will be. Furthermore you will be able to
protect your company’s short-term reputation as well as position it for
The first step towards taking control of, and properly
managing your company’s cash flow is to analyze the components that affect the
timing of your cash inflows and outflows. A thorough analysis of these
components will reveal problem areas that lead to cash flow gaps in your
business. Narrowing, or even closing, these gaps is the key to cash flow
Some of the more important components to examine are:
Accounts Receivable. Accounts receivable represent
sales that have not yet been collected in the form of cash. An account
receivable is created when you sell something to a customer in return for his or
her promise to pay at a later date. The longer it takes for your customers to
pay on their accounts, the more negative affects there will be on your cash
Credit terms. Credit terms are the time limits you
set for your customers' promise to pay for the merchandise or services purchased
from your business. Credit terms affect the timing of your cash inflows. One of
the simplest ways to improve cash flow is to get customers to pay their bills
Credit policy. A credit policy is the blueprint you
use when deciding to extend credit to a customer. The correct credit policy is
necessary to ensure that your cash flow doesn't fall victim to a credit policy
that is too strict or to one that is too generous.
Inventory. Inventory describes the extra
merchandise or supplies your business keeps on hand to meet the demands of
customers. An excessive amount of inventory hurts your cash flow by using up
money that could be used for other cash outflows. Too many business owners buy
inventory based on hopes and dreams instead of what they can realistically sell.
Keep your inventory as low as possible.
Accounts payable and cash flow. Accounts payable
are amounts you owe to your suppliers that are payable sometime within the near
future, "near" meaning 30 to 90 days. Without payables and trade credit you'd
have to pay for all goods and services at the time you purchase them. For
optimum cash flow management, you'll need to examine your payables schedule.
Some cash flow gaps are created intentionally. That is, a business will
sometimes purposefully spend more cash to achieve some other financial results.
For example, a business may purchase extra inventory to take advantage of
quantity discounts, accelerate cash outflows to take advantage of significant
trade discounts, or spend extra cash to expand its line of business.
For other businesses, cash flow gaps are unavoidable.
Take, for example, a company that experiences seasonal fluctuations in its line
of business. This business may normally have cash flow gaps during its slow
season and then later fill the gaps with cash surpluses from the peak part of
its season. Cash flow gaps are often filled by external financing sources.
Revolving lines of credit, bank loans, and trade credit are just a few of the
external financing options available that you may want to discuss with your
|Managing Your Cash Flow
||Now that you have considered how your business practices
affect your cash flow, you are ready to develop some additional strategies for
dealing with, narrowing, or closing cash flow gaps.
Contingency plans. You should have a “life is
beautiful” plan a “life is life” plan and a “don’t even talk to me about life”
plan. The first plan forecasts high sales, low expenses and everything going
better than expected. The second is based on realistically achievable sales and
honest expenses. The third plan specifies how to survive if everything goes
wrong. The flag for going from the realistic plan to the survival plan is a
sudden or steady decline in sales.
Cash Forecasting. The biggest problem for business
start-ups is the owner failing to plan for how much cash the business needs
throughout the year. This applies especially to businesses where payments
usually come in over several months or after the work is complete. Business
owners must also forecast expenses that aren’t due each month, such as annual
Spending Controls. Keep an eye on all spending; try
to keep enough money in the company to get through tough times. New business
owners are often tempted to spend too much for nonessentials. Make sure you
carefully negotiate leases and solicit price quotes from several vendors to find
the best value. Also, stop selling products that are losing money and avoid
buying assets that require substantial cash outlays.
Accumulate Salary. If necessary to maintain a
positive cash flow, you may need to forfeit part of your own salary. Many
entrepreneurs go bankrupt because they don’t pay attention to the financial
state of their business and insist on paying themselves big salaries no matter
Add Employees cautiously. Delay hiring workers as
long as possible. Instead, look for ways to maximize your own productivity and
that of any existing employees. Also consider lower-cost alternatives, such as
outsourcing work to independent contractors.
|What To Do With A Cash Surplus
||Managing and improving your cash flow should result in a
cash surplus for your business. How you handle your cash surplus is just as
important as the management of money into and out of your cash flow cycle.
Paying down any debt you have is generally the first
option you should consider when deciding what to do with your cash surplus,
because a short-term investment is not likely to yield a return equal to or
greater than the rate of interest on any of your debt. However, the decision to
automatically pay down debt may not be correct in all cases. Your accountant is
the best person to help you make these decisions.
Monitoring and managing your cash flow is an important
task to perform in order to ensure the vitality of your business. The first
signs of financial woe will appear in your cash flow statement, giving you time
to recognize a forthcoming problem and plan a strategy to deal with it.
Furthermore, with periodic cash flow analysis, you can head off those unpleasant
financial glitches by recognizing which aspects of your business have the
potential to cause cash flow gaps. With cash flow management and analysis, you
will be able to plan on how you’re going to direct your cash surplus with
assurance that you will have adequate funds to cover day-to-day expenses.
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Happiness is a Positive Cash Flow