Cash flow is a unique aspect of any business that can provide crucial insights into its well-being and strategy. Some of the tactics that small businesses can use to manage cash flow include finding the right accounting software, building cash reserves, and more.
According to the U.S. Bureau of Labor Statistics, as referenced by the Chamber of Commerce, almost half of all startups close their doors within the first five years. The biggest challenge they face? Cash flow issues.
What Is Cash Flow?
Cash flow represents the money that enters or leaves a business account during a designated period. Usually, companies evaluate cash flow quarterly or annually through a financial report called the statement of cash flows.
Cash flows are broken down into three distinct types:
- Financing Activities: Anything involving paying creditors or borrowing funds to finance business operations
- Operating Activities: Cash spent on day-to-day business functions and working capital
- Investing Activities: Investment in long-term assets that can contribute to overall business growth
Cash flow is either positive or negative. Positive cash flow signals that your company has more money coming in than leaving, while negative cash flow denotes the opposite. Negative cash flow is not necessarily a bad thing, however, especially for businesses just getting off the ground.
How to Calculate Your Cash Flow?
Cash flow is typically calculated through a statement of cash flows. The statement of cash flows takes all of your business activity from financing, operating, and investing activities, then subtracts everything that you spent cash on during the reporting period.
A simple formula for cash flows is: Net Cash Flow = Total Cash Inflows - Total Cash Outflows. Always make sure that the ending cash balance matches the number on the balance sheet. If the numbers do not align, recheck your math or bookkeeping entries to ensure nothing was missed or recorded incorrectly.
How Can Small Businesses Manage Cash Flow Successfully?
Utilize Appropriate Software
Find bookkeeping software that works best for your business. Many software programs offer free trials, so you can get a feel for the software without the financial commitment.
The type of software you choose depends on whether you need something simple or a fully built-in bookkeeping solution. Many software programs, for example, also handle invoice processing, accounts payable, and other functions, all in one convenient location.
If using accounting software is too complicated, it may be worth it to find a qualified bookkeeper. You may only need to hire help for a few hours a week on a contract basis, which can save you time and money in the long run, along with eliminating the hassle of complex accounting solutions.
Build Cash Reserves
According to Melio, a small business should have approximately three to six months' worth of expenses saved in an easily accessible account. You may need to have more, depending on factors such as the type of business you run and your comfort level. Small businesses in unpredictable sectors might have more peace of mind with a bit of extra cash in reserve to cover unforeseen costs.
To maximize your cash reserves, it is important to bank with a financial institution that you can trust. Get more info from experts at Georgia Banking Company to determine which type of account is best for managing your liquidity needs.
Tying up cash in physical or long-term assets might seem like the right move at the time, but it could actually be detrimental if you quickly need funds. A smaller cash reserve may cost you later on if you need to borrow money at higher interest rates or sell equity for less than you originally intended.
Tightly Manage Your Accounts Receivable System
It may seem easy to let customers or clients off the hook for unpaid bills. However, these can add up and cause significant problems with your cash flow. When those invoices do not get paid, your business will not have the funds to support itself.
Offer incentives to customers to pay invoices early, such as small cash discounts. Try to receive payment in cash whenever possible, so you will not have to chase them down for payments.
Regularly send out invoices on a designated day of the week or month. Run accounts receivable reports regularly to see where money is missing and contact your customers with payment reminders.
Frequently Asked Questions
Is Cash Flow Just Profit?
No. Cash flow and profit can intersect at some points during the accounting process, but are often separate.
Cash flow specifically refers to cash entering or leaving a bank account. Therefore, some profits may be positive cash flows, while others might not impact the statement of cash flows.
If a company sells products on account, for instance, it would record a profit when they make the sale, not when they receive actual payment. However, since the entry would go to accounts receivable, it would have no impact on actual cash flow.
Can You Be Cash Flow Positive But Not Profitable?
Yes. While more cash is generally positive, it does not give the entire picture of the health of a business.
A business could lack financial planning and need to secure outside funding to stay afloat, for example. Placing business expenses on credit or relying on other sources of income might make it appear as though the business is more profitable on paper if you only rely on the statement of cash flows.
Other examples of manipulating cash flows might include:
- Postponing payments to vendors
- Accepting large amounts of funding up front from customers
- Recording transactions in the wrong period
How to Tell if a Company Has Good Cash Flow?
Many different factors influence the financial health of a business, and cash flow is a small piece of a complex puzzle. However, good cash flow and accurate recordkeeping are indicators that the company is doing well.
Effectively Navigate Your Cash Flow
As a business owner, your cash flow is one of the most important numbers to track. With this guide, you can ensure that your company stays in the black and that you have enough cash to meet unanticipated needs.
Would you like more tips and tricks for running your own business? Take a look around our website today for ideas and inspiration.
This article was prepared by an independent contributor and helps us continue to deliver quality news and information.
