In order for your business to be as successful as possible, you need to have a firm grasp on cash flow. Understanding your cash flow and how to manage is essential for long-term stability and confronting issues in the short term.
What is cash flow?
Cash flow is, as the name suggests, the manner in which cash flows through your business. Because of this, it is possible to have a negative cash flow — where you have more cash going out than you have coming in. If you have more cash coming into your business, you have a positive cash flow. Per Investopedia, liquidity allows your business to, among other things, reinvest, pay off debts, cover expenses and needs or boost payouts for shareholders and employees.
How is cash flow determined?
As The Balance Small Business’ Rosemary Peavler notes, cash flow is not the same thing as profit, so it’s not something that can be so easily assessed looking at a profit and loss statement. Instead, QuickBooks recommends basing a cash flow analysis on three factors: accounts receivable, accounts payable and, if applicable, shortfalls. Inc.com also recommends considering your inventory and capital expenditures when compiling a cash flow statement.
To create a cash flow statement, you can use two methods suggested by Quickbooks: the direct method that tracks all inflowing and outflowing cash, or the indirect method that accounts for depreciation. While there are many helpful tools and programs that enable you to create your own cash flow statement, you can also turn to a trusted financial professional if you want to be positive of the results.
Strategies for improving cash flow
Once you have determined what your cash flow is, whether positive or negative, you can devise methods for improving it. If you are in the positive, you’ll want to prioritize keeping cash reserves on-hand to provide security in the event of eventual shortfalls or downturns. Just as you’d want to keep a nest egg for your personal use, you want liquid cash available should you need it in the event of an emergency.
A seemingly obvious method for improving your cash flow is to increase your sales. Inc.com warns that you may wind up spending more cash trying to acquire new customers than you would selling more to existing customers, but the SBA counters that selling more to current customers may only increase your accounts receivables. Whether you get new customers or more purchases from current customers, you’ll want to implement a strategy for payment that gets cash into your account faster.
If one of the areas that you find yourself struggling in is accounts receivable, Caron Beesley, a contributor for the Small Business Administration’s Managing a Business blog, recommends offering a discount for cash on delivery or paying more quickly. This allows you to receive the cash in a timelier manner and cuts down on the time that you’d need to chase down payments from customers. Peavler suggests a lockbox system for payment collection that expedites the time it takes for payments to be put into your account and allows them to be swept into an interest-bearing account.
Peavler cites inventory as another significant asset that can hinder cash flow. Inventory that sits for too long or sells out too quickly can have a negative affect on the flow of cash into your business, which is why it’s important to know your inventory turnover ratio. If it turns out that you can be more efficient with inventory turnover, you can adjust accordingly to optimize cash flow.
Cash flow is just one of the many factors that you have to constantly monitor in the effort of guiding your business to success. If you need help determining your business’s cash flow or managing it, consider consulting with a financial professional so that you can focus more on the various other aspects of your business.