While tracking the money coming in and out of your business may sound like an easy task, many small business owners struggle with understanding the importance of cash flow management. Cash flow is an essential part of a business's health - but how do you keep it in the positive?
Cash flow is the lifeblood that keeps your doors open, your team paid and your products on the shelves. What you may not realise is that it also affects whether you have enough money to keep growing, which requires investing in new equipment, hiring new employees or paying yourself a salary.
Unfortunately, many small and medium sized enterprises (SMEs) don't have a good handle on their cash flow mainly because they don't understand how it works or how much they need to maintain a positive cash flow month after month.
In this article we'll look at the basics of cash flow, why it matters for small businesses like yours and how to improve cash flow so that you can take advantage of opportunities when they arise!
| What is Cash Flow? | How to Improve Cash Flow |
| Why is Cash Flow Important? | Cash Flow vs. Net Profit |
| Positive and Negative Cash Flow | What is a Cash Flow Forecast? |
What is Cash Flow?
Cash flow is the difference between the cash you take in and the cash you spend. It's a measure of how well your business is performing and can be an early indicator of potential problems.
Why is Cash Flow Important?
As a basic concept there should be more money coming in than going out.
Why is cash flow important? In order to effectively manage money and make strategic decisions that will change depending on what stage of the business lifecycle you're in, you'll need a picture of where you stand financially at any given time - like if you're taking in more money than your spending (or the other way around).
Calculating net cash flow is quite straight forward, although the exact formula may vary slightly between businesses depending on their income and expenses, or even changes in their working capital.
The Cash Flow Formula
Your cash flow plays a critical role in nearly every aspect of running your business, especially monthly expenses like rent, payroll and inventory purchases.
If you haven't already, you should start tracking monthly outgoings, as well as sales or payments received from customers - basically any cash in and cash out of the business.
Positive and Negative Cash Flow
Your cash flow can be positive or negative - but we'll let you take a guess at which one is better for business!
What is Positive Cash Flow?
Positive cash flow is when your business's cash inflows exceed its outflows - in other words, when you have more money coming into your business compared to going out. It is one of the most important financial metrics to monitor in any business. If your cash flows are positive, it means you're make money and can use that income in many different ways.
Having a positive cash flow means:
- You're able to pay your bills on time
- You have more money in the bank
- Your business is more likely to achieve sustainable growth
If we took all of the income that came into your organisation over the past year and subtracted all of the expenses (including tax) during that period, we would be left with a figure called "net profit".
What is Negative Cash Flow?
A negative cash flow is a situation in which your business has expenses that are greater than its sales or income. This means that the money you're taking in isn't enough to cover your expenses and pay off any debts. If this continues long enough there could be serious consequences.
Your business might have a negative cash flow do to:
- Late or non-payments from customers
- Under charging for your goods and services
- Unplanned expenses or unexpected costs
- Your sales being dependent on seasonality
How to Improve Cash Flow
For small businesses improving cash flow can be a challenge, particularly in the start-up or early growth stages.
There are several ways to improve cash flow, including:
- Increasing sales - offering discounts or free shipping are two common methods used to bring in more sales during a down time; however, you need to ensure that you're not undervaluing your goods or services. As an alternative, you can work on your product value proposition and make your product the best out there - have client testimonials to back it up!
- Collecting accounts receivables quicker - getting paid on time is key to the success of your small business! Define clear payment terms for your customers, send invoices out ASAP, stay on top of payments due, send reminders and take action when necessary. Additionally you may want to consider:
- Including penalties or late payment fees
- Collecting deposits on orders, particularly larger ones
- Offering discounts for customers who pay in full upfront or pre-order
- Finding suppliers who will work with you on flexible payment terms
- Implementing a credit control strategy
- Investigating opportunities for additional funding
- Maintaining a cash flow forecast
Cash Flow vs. Net Profit
The main difference between cash flow and net profit is that net profit only accounts for money changing hands, while cash flow accounts for both incoming revenue and outgoing expenses. This means that sales revenue doesn't contribute directly to cash flow unless there is extra money left after paying off expenses - and even then, some sales might have been paid for with credit or deferred payments, so they don't count as 'cash' yet either!
What is Cash Flow Forecasting
Cash flow forecasting is the process of predicting your future cash flow by analysing the movement of cash coming in and out of your business over a specific period of time. Your forecasting method will be determined by your business objective and the availability of financial information.
There are two main types of forecasting methods: 'direct forecasting' which is more appropriate for short term objectives and 'indirect forecasting' suitable for the long term.
How can DSA Prospect Help?
Understanding your cash flow is crucial to running a successful business. Having enough cash on hand to cover expenses, pay vendors and employees, and reinvest into the business will help you thrive in today's competitive market. And if you can predict when those payment will come due ahead of time (through forecasting), then you'll be able to plan accordingly.
A cash flow problem can be overwhelming and stressful for small business owners. Our team can analyse your cash flow, assess business performance and help you secure financial support if needed to keep your business growing!
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