Healthy Cash Flow Strategies For Your Small BusinessYou’ve probably heard the saying, “Cash is King,” – and truly, a healthy Cashflow is a vital part of any successful business. Net income doesn’t pay the bills and neither do the assets or equity in your business. Only cash pays the bills.
Without a doubt, proper Cashflow management in your business is critical to its growth and longevity. Understanding basic Cashflow principles is the first step in effectively managing your Cashflow.
Cashflow is more than just a fancy term. In its simplest form, Cashflow is the movement of money in and out of your business. It can be described as the process in which your business uses cash to generate goods or services for sale to your customers, then collects that cash from each sale and completes the cycle all over again.
Let’s look at each flow of cash:
Inflows: Inflows are the movement of money into your cash flow. Inflows most likely come from the sale of your goods or services to your customers. If you extend credit to your customers and allow them to charge the sale of the goods or services to their account, then an inflow occurs as you collect on the customer’s account. The proceeds from a bank loan, money received from investors or sale of assets are also cash inflows.
Outflows: Outflows are the movement of money out of your business. Outflows are generally the result of paying expenses. If your business involves reselling goods, then your largest outflow is most likely the purchase of inventory. A manufacturing company’s largest outflows are usually the purchases of raw materials and other components needed for the production of their final product. Purchasing fixed assets, paying down debt and reducing accounts payable are also cash outflows.
Accounts Receivable and Cashflow Accounts: Receivable represents sales that have not yet been collected as cash. You sell your merchandise or services in exchange for a customer's promise to pay you at a certain time in the future. If your business normally extends credit to your customers, then the payment of accounts receivable is likely the single most important source of cash inflow.
In the worst case scenario, unpaid accounts receivables will leave your business without the necessary cash to pay its own bills. More commonly, late or slow-paying customers will create cash shortages, leaving your business without the cash necessary to cover its own cash outflow obligations.
Knowing your Receivable Turnover Ratio (RTR) can provide great insight into your account receivable position. You calculate ratio by dividing annual sales by the total dollars of outstanding receivables. To break this metric down into days, just divide your RTR by 365 to give you the average number of days it takes for you to collect on outstanding receivables.
In addition, you should print a weekly Accounts Receivable aging schedule and ensure frequent and appropriate contact is made to collect the money owed to you.
Statement of Cashflow: Every business owner should also have a Statement of Cashflow for their business prepared at least monthly, along with their income statement and balance sheet.
The Statement of Cashflow reports Cashflow generated over a period of time in each of the three key activities of a business: investing, operating and financing activities.
While each financial statement provides unique information of use for analysis and decision-making, the Statement of Cashflow provides particular insight into that most vital commodity – cash.
Every business owner should develop a good understanding of basic Cashflow principles and then analyze the various areas that affect the timing of cash inflows and outflows in your business.
A good analysis of these components will point out problem areas that lead to Cashflow gaps in your organization. With this information, you can develop a Cashflow plan to help you foresee the needs of capital, along with identifying potential sources of operating capital that can help you fund the ongoing activities and needs of your business.