April 11, 2022
Small business owners must deal with a long list of challenges, from acquiring and retaining customers to hiring reliable staff. However, managing cash flow is often one of the largest obstacles.
Here is what you should know about cash flow management for small business owners.
What Is the Definition of Cash Flow?
The first step in managing cash is understanding how cash flow works. Cash flow is the net amount of cash transferred in and out of a company.
Businesses have a cash inflow and outflow. Inflow includes cash received, whereas outflow includes business costs. Examples of cash inflows are payments from customers, interest earned from bank accounts, and refunds from suppliers or vendors, such as from suppliers or vendors.
Operating costs, such as wages, lease payments, equipment rental or purchase, and supplies or inventory, usually come out of the cash flow.
Cash Flow and Business Profit Are Not the Same
Positive cash flow indicates that your business is receiving more money than it is spending. However, this is not the same as profit.
For example, you spend $5,000 on inventory that you turn around and sell for $10,000. You technically gained $5,000 in profit. However, if you need to wait for payments from customers, you may not experience positive cash flow during the same period. You may even experience negative cash flow until the payments start coming in.
Start Analyzing the Cash Flow of Your Business
Analyzing your cash flow gives you a better indication of the day-to-day inflow and outflow of money. Understanding the flow of money can help keep your business from dealing with a lack of resources while waiting for accounts receivable. This is a cash–flow gap.
If you are waiting on payments from customers, you may not be able to meet your financial obligations. Business owners may have to sell off inventory, cut back on operations, or make late payments to vendors and suppliers if they don’t have enough money.
Create a List of Cash Inflow and Cash Outflow
Analyzing your cash flow requires you to look at the money coming in and out of your business. However, if you want to figure out how long your business can last, you should look at how much money your business makes from its operations.
Start by listing all cash received from customers during a specific period. This includes all income from the sales of goods and services.
Do not include any pending payments. Only include payments that have already been made. payments that you have already received from customers.
Next, create a list of all incoming operating activity expenses. This includes the cost of inventory, supplies, and materials to produce or offer your goods or services. You also need to include labor costs, utility bills, lease payments, and payments to contractors and vendors.
Subtract the total expenses from your total incoming cash to determine your net income. If you have a positive figure, you have a positive cash flow.
If you have a negative figure, your business is spending more than you are taking in, which limits the growth and sustainability of your company. It can also happen when a customer takes longer than expected to pay off their debts.
Estimate the Future Cash Flow of Your Business
Along with analyzing previous months and quarters, you can estimate future cash flow. Use the same steps described above. Start by creating a list of all cash inflow and outflow. However, your list of incoming money should include accounts receivable.
Accounts receivable include sales that you have not yet collected. Customers who haven’t paid yet for the next month or quarter should be included.
When creating a list of expenses, you should also include upcoming accounts payable. In this case, you should include payments to vendors or suppliers that are due during the time you want to look at.
Biggest Factors That Create Gaps in Your Cash Flow
A gap in your cash flow occurs when your expenses exceed your income. This can happen for a number of reasons, including when customers don’t pay on time.
Adjusting your credit terms or credit policy may help you receive payments more quickly. For example, instead of installment payments over a period of 12 to 24 months, you can shorten the term to six months. Increasing late penalties may also encourage customers to pay their bills on time.
Excess inventory can also lead to cash flow gaps. For example, holding on to too much inventory may increase storage and labor costs. You may also use up funds on goods that you may not sell immediately.
Maintaining a smaller inventory and focusing on items that you can sell quickly can help reduce the risk of negative cash flow. If you run a service-based business, you can focus on cutting down on things like supplies and wasted space in your building.
Not Reviewing Your Balance Sheet
At least once per month, you should review your balance sheet and analyze your cash flow. However, if you have already had bad money, you should think about reviewing your income and expenses even more often.
Seasonal operations can also lead to gaps without positive income. Companies that only operate during certain seasons of the year tend to have seasons without money coming in.
For example, if your company only operates during the winter, you may experience negative cash flow throughout the rest of the year. In these situations, you need to plan for the entire year instead of looking at your finances each month or week.
In order to figure out if your income during your active season can cover your expenses during your inactive season, you need to do a very detailed analysis that covers the whole year.
Dealing with a gap in your cash flow may keep you from having the funds needed to cover financial liabilities. If you can not pay rent, labor, or vendors, you may struggle to keep your business open.
The key to managing cash flow is to pay attention to everything that you spend and everything that you earn. Perform a detailed cash flow analysis at least once per month, if not more frequently. You should also think about accounts receivable and accounts payable when you figure out how much money your business will make in the future.
If you need help with your bookkeeping and accounting, don’t hesitate to schedule a consultation with us!
Even though we are based in Albany, NY, we offer our expertise in business accounting, bookkeeping, and tax preparation all across the United States.