Today, let’s dive into the financial lifeblood of your small business – cash flow!
Poor cash flow is often cited as the biggest threat to a businesses’ stability and ability to trade, so understanding it is crucial to success.
Sure, it might sound like accounting jargon, but trust me, understanding cash flow is like having a financial compass for your business.
Let’s find out what it is, how it works, and how you can analyse it in your own business.
What is cash flow?
Cash flow is the movement of money in and out of your business, the oxygen that keeps your venture breathing and thriving. In simple terms, it’s the net amount of cash your business generates and spends over a specific period.
Make sure you don’t confuse cash flow with profits. Your business can be profitable on paper, but if actual cash isn’t moving into your business quickly and regularly, at the right time, you might find yourself without the requisite liquidity to cover expenses when required and bank real profits.
How does cash flow work?
Cash flow is the lifeblood of your business and speaks to the continuous movement of financial resources.
Cash flow is a dynamic cycle where money enters, as inflows, through channels like sales revenue, investments, and owner contributions. Cash then departs, as outflows, to cover operational costs, expenses, payroll, loan repayments, taxes, and other investments.
The essence lies in balance; your business must find the right equilibrium between incoming and outgoing funds to maintain a healthy financial state. Understanding how cash flow works empowers business owners to navigate the financial landscape, foresee financial patterns, and sustain a steady path to solid financial health and business success.
Let’s look at inflows and outflows to understand cash flow more fully.
What are Inflows?
Inflows are sources of cash that enter your business in a variety of means. Some key examples include the following.
Sales revenue is often a primary source of business funds. The concept is simple enough – when customers buy your products or services through sales activity, you have a large source of revenue to either spend elsewhere, or bank as profits.
Investments and loans
Sometimes, your business receives a cash injection from investors or loans. Many business owners take out a business loan to fund startup costs or large business purchases. Many others will court investors to own a stake in your business. Either way, this will result in an immediate cash resource that can be used to fund various business costs or investments.
Owner investment represents your own financial contributions to the business. This will often be from your own savings or may result from the sale of your own property to provide your business with funding.
What are outflows?
On the other hand, outflows represent all of the cash you need to spend to keep your business going. Some key examples of outflows include:
Operational costs are expenses that are vital to the daily running of your business. Think – rent, utilities, staff wages, and raw materials. These are your regular bills that need to be paid to keep your business humming along.
Obviously, if you have business loans, they certainly need to be paid off regularly, as per your loan agreement. Make those monthly payments to keep your financial house in order.
The unavoidable necessity of paying your taxes will be another major outflow. Set aside cash to cover your tax obligations – no one likes a surprise tax bill.
Often, you need to spend money to make money. Investing in growth can be another significant outflow. Whether it’s upgrading equipment or expanding your team, these are intentional moves to elevate your business performance.
How do you analyse your cash flow?
Now that we’ve got the basic steps down, let’s analyse that cash flow to keep your finger on the pulse.
One of the best tools in your arsenal for tracking and analysing cash flow is your accounting software. Oftentimes it will have all the figures and information you need as well as reporting functionality to make cash flow analysis much simpler.
Create a cash flow statement
Start by preparing a cash flow statement. This document tracks your inflows and outflows, providing a snapshot of your business’s financial health.
Monitor your cash flow regularly
Don’t let your oversight slip or you could miss impending strife. Regularly review and update your cash flow statement – weekly, monthly, whatever suits your business tempo. This helps you spot trends, anticipate issues, and celebrate financial victories.
Identify seasonal trends
Every business will have slow and busy periods. It pays to identify seasonal patterns in your cash flow to prepare for less or more revenue.
Does it peak during the holiday season? Is there a period with very little inflow? Understanding these trends helps you plan for the quieter moments, or put aside cash in busy times for a rainy day.
Manage your accounts receivable and accounts payable
Keep an eye on your accounts receivable (money owed to you) and accounts payable (money you owe). Prompt invoicing and timely payments can be the wind beneath your cash flow’s wings.
Some ways to shore up your cashflow
Beyond monitoring, managing, and reporting, there’s a few extra ways you can help shore up your cash flow and keep it healthy.
Build an emergency fund – your financial first aid kit
It pays dividends to be prepared and build an emergency fund. This buffer can help you navigate unexpected expenses or a temporary dip in cash flow without missing a step. Make use of busy periods to put cash aside for the ebbs.
Negotiate better terms
Negotiate more favourable payment terms with suppliers and clients. Sometimes, a little financial flexibility can make a significant difference to your cash flow.
Make strategic investments that align with your business goals. Whether it’s technology upgrades or staff training, these investments should contribute positively to your cash flow in the long run.
If you’re still unsure of how to better manage cash flow, invest in good quality accounting software and consult with a bookkeeper, accountant, or business advisor to get a firmer handle on it.