Cash flow acts as a key pointer of how financially healthy business is. There is an old saying that goes, “Cash is king.” It means that cash flow remains to be one of the most critical aspects of any enterprise.
So what is Cash flow?
Cash flow means the overall amount of operational cash that comes into a business and goes out of it. It’s also the net balance in the position of cash in a business from one period to another.
If your business absorbs in more cash than it gives out, its cash flow is said to be positive, and if it has more cash going out than the one coming in, then it has a negative type of cash flow. Mastering the art of managing cash flow in a business is essential to keep your business operations running.
The gap between paying off the outstanding expenses and waiting for payments from your clients can give anyone sleepless nights. Having liquid cash creates more stability since it increases your buying power and also ensures that you have funds enough to offer you a greater safety net against foreclosures and defaulters.
Cash flow means a different thing from a cash position. It is critical to have enough cash-on-hand, but if you have a positive cash flow, it indicates an ability to make and use the money. The cash situation is the liquidity of a business. Deposit accounts in the bank or in a stock market that can be sold easily are liquid assets. On the other hand, properties like buildings are illiquid. Liquid assets can be said to be those that are easily converted into cash.
Without cash your business won’t run, your workers can turn out to be cranky, and even suppliers can discontinue their shipments to you. If you run out of money, it does not necessarily mean that your business is not very profitable. You need to maintain a cash flow statement of your business consistently to help you create excess cash to sustain the business operations.
It brings us to our next question, what is a cash flow statement?
A cash flow statement is a statement that tells you where the money went or rather where you spent your money. A statement of cash flow can assist you to focus on the creation of excess cash. Having profits is good, but it is just one of the things that help generate some money, other things can also help you build some cash.
If you can pay less for capital equipment you need, you are generating cash while spending money. If you can collect receivables from your customers sooner than scheduled, you are creating excess cash. If you efficiently control the use of your inventory, you’re creating excess cash. Concentrating only on your profit and loss statement makes it difficult to focus on the available liquid cash. Cash flow statements may provide an even better Key Performance Indicators (KPI’s) than profit and loss statements do.
Companies that concentrate on creating excess cash often also generate better enterprise value than those companies that only focus on the profits. Cash flow statements help business in making sound financing decisions when buying capital equipment, growing capacity of your company, adding inventory and even adding customers.
You need to know how you’re going to finance company growth. Sometimes you’ll use excess cash gotten from profits while other times you’ll have to borrow money from the bank. Sometimes, you’ll need to raise capital from outside especially if the business is still young.
If you understand where your cash goes and how you will provide more money when you need it, you can run a successful company, and it can allow you to make better decisions about your business. To better understand how to control cash flow, let’s first look at the difference between cash outflow and cash inflow
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The Difference Between Cash Outflow and Inflow
Cash that gets into any business is the cash inflows and is mostly generated from selling goods or inventory and is also the money made from services offered by the firm. Money that pays for the expenses incurred in the operation of the business is what is referred to as cash outflow. The difference between these two costs is known as net cash flow and can either be positive or be negative.
When the money the business receives is higher than its expenses, then we say that the cash flow of the company is positive. In this case, the enterprise can cater to its bills. High positive cash flow is better and will allow you to expand your company, make investments like hire employees or open another branch to grow your business further.
A cash flow that is negative shows that the business receives less money than it spends. The firm, in this case, will be struggling to meet its immediate cash needs and may result in borrowing money to cater for the deficit. If there’s negative cash flow, it means more money is going out than is coming in.
Cash inflow is the businesses’ lifeblood (Reider & Heyler, 2003). Cash inflow means the money that you accumulate through invoice payments from your customers, loans, interest money on your savings or investments as well as cash infusion from investors. Cash outflow aspect is also vital since it forms the cash you need to make payment for things that make your business run such as expenses to buy stock or raw materials, pay employees, rent and other operating expenses.
How to Control cash flow
Controlling cash flow in a business is vital, and companies must ensure that specific issues are adequately dealt with including:
- Ensure that there is enough and available money for investments
- Place proper procedures to ensure efficient collection of outstanding debts
- Control various levels of money spending concerning business size
If you want to improve the cash inflow, there are a few things you can do.
How to Improve Incoming Cash Flow
If you billed your customers and they delay their payment, it can make your business planning tricky. Some of the tactics that businesses can adapt to encourage clients to clear their bills faster include:
- Issuing invoices on time and following up on them on a regular basis.
- Give discounts for timely payment of bills and invoices.
- Structure the debt with a deposit given up-front and if the project is long-term, plan the series of intervals for payment in the course the project lifetime.
Conversely, here is how to create smart cash outflow:
- Pay Your Obligations Smartly
Building trust with your creditors is essential. One way to achieve it is to clear your bills on time. Some of the techniques to help pay off your bills on time and to ensure that you have a positive cash flow include:
- Take advantage of the full payment term
If you’re offered a payment term of thirty-days on a particular bill, you can utilize all the days to help you accumulate the cash. Thus, you’ll handle the cash flow efficiently than when you make payment the same day you get the invoice. Alternatively, check if you’ve been offered discounts for making payments to your suppliers earlier than the full term indicated.
- Ask the supplier if they have flexible terms of payment
If you do not inquire about flexible terms, you may never get to know, and yet if you find out about it, it can help you sort out your cash flow issues to a certain level. It’s important to know but enquire about the possibility of flexible terms of payment before a deal is sealed since if you do it, later on, it can raise suspicion. So, ask about it smartly especially when you don’t have any cash flow issues.
- Create ETF payments.
You can clear your bills immediately they are due if you set fixed ETF payments, but it gives you an option of not releasing the funds if you’re not yet ready.
- Create a real bond with your suppliers and vendors
If you’re honest with your creditors and they can trust you, it could help you a great deal especially when the time comes to ask for payment term extension.
Anything is possible, and there can be a holdup between sales and the time of payment receipt which can result in less cash flow to use in the business operations. So, how can you survive the lean months?
How to Survive the Lean Period
- Build up enough cash reserves – Evaluate your history of cash flow and work out an ideal estimate of the cash reserves that would sustain your business for some few months and even a year. If you know the numbers, it can be of great help to you when you want to visualize the big picture and when you want to make improved business decisions.
- Organize a credit line with your lenders – Talk with your lenders about the possibility of borrowing money up to a certain preset limit when you need it before it happens.
So that said and done, how important is cash flow to your enterprise?
Importance of Cash Flow to a Business
- Helps you manage your obligations
If you take out a loan to purchase inventory or equipment, you primarily use prospected cash flow to buy items now. You need to have a positive cash flow in future to be able to repay any debt commitments.
Often, companies have credit accounts that are either long or short-term with various vendors, and each debt requires monthly repayments. Since you’re obligated to make the repayments on a regular basis, it limits the free flow of cash, which is money available for investing for the growth of the business
Steady cash flow also provides the security and capabilities any company requires to use on growth. You can use the cash to set up new locations, invest in research or development, renovate infrastructure, improve technology, provide extra training and buy additional assets and inventories and thus grow and also improve the business.
If you have a surplus cash flow, it helps your business operate strategically and proactively, rather than an in a reactive and defensive approach.
Adequate cash flow allows for greater flexibility in your business when dealing with emerging emergencies or when making important choices. Steady cash flow raises the status of the company and makes it more attractive to lenders if you consider taking out new debt. It also gives you the power to offer fair credit terms while also attracting new buyers.
How to Avoid Cash Flow Surprises
You need to plan for upcoming expenses and predict income ideally for the next three months, three weeks or even three days if that’s what your business is possible to achieve. It helps to be at par with your financial pulse and quickly identify potential problems earlier on.
You can align high-priority bills with early payments and work down the scale from there but don’t wait until the end of the month to write all your checks at once. Never make a payment until the cash is in the bank. Many mistakes are committed when in crisis for example if you assume a deposit will be timely and make the payment before it arrives.
- Don’t wait until it’s too late
Talk with your lender about possibilities for future credit lines before you encounter a financial emergency. If you establish a potential for future backup plans, it reassures your bank that you’re planning, which makes an excellent case for why they should lend you money when the moment arrives. Try to prepare for about two months of back up, and with a bit of luck, you may never need to use all of it.
- Give Notice Sooner Than Later
Don’t wait until day 26 to remind your customer about a 30-day payment since it can create an unpleasant experience for both you and your customer. Establish a consistent payment reminder to keep away cash flow issues and to identify any potential problems early on. You can always offer discounts on early payoffs to motivate them to pay.
- Involve everyone
If you take the full responsibility for all the business finances, it can be quite overwhelming. Get everyone involved and hold each team accountable for their contribution to the process. It is possible for employees to identify a potential risk sooner than you since they’re working more closely with day-to-day tasks.
Maintaining good cash flow is vital to keep the business running. Small business owners need to control their cash flow for the company to flourish.