Many small business owners do not fully understand their cash flow
statement. This is surprising, given that all businesses essentially
run on cash, and cash flow is the lifeblood of your business.
Some business experts even say that a healthy cash flow is more
important than your business's ability to deliver its goods and
services! That's hard to swallow, but consider this: if you fail to
satisfy a customer and lose that customer's business, you can always
work harder to please the next customer. But if you fail to have
enough cash to pay your suppliers, creditors, or employees, you're
out of business!
What Is Cash Flow?
Cash flow, simply defined, is the movement of money in and out of
your business; these movements are called
inflow and
outflow. Inflows for your business primarily come from the
sale of goods or services to your customers. The inflow only occurs
when you make a cash sale or collect on receivables, however.
Remember, it is the cash that counts! Other examples of cash inflows
are borrowed funds, income derived from sales of assets, and
investment income from interest.
Outflows for your business are generally the result of paying
expenses. Examples of cash outflows include paying employee wages,
purchasing inventory or raw materials, purchasing fixed assets,
operating costs, paying back loans, and paying taxes.
Note: An accountant is the best person
to help you learn how your cash flow statement works. Please contact
us and we can prepare your cash flow statement and explain where the
numbers come from.
Cash Flow Versus Profit
Profit and cash flow are two entirely different concepts, each
with entirely different results. The concept of profit is somewhat
broad and only looks at income and expenses over a certain period,
say a fiscal quarter. Profit is a useful figure for calculating your
taxes and reporting to the IRS.
Cash flow, on the other hand, is a more dynamic tool focusing on
the day-to-day operations of a business owner. It is concerned with
the movement of money in and out of a business. But more important,
it is concerned with the times at which the movement of the money
takes place.
Theoretically, even profitable companies can go bankrupt. It would
take a lot of negligence and total disregard for cash flow, but it is
possible. Consider how the difference between profit and cash flow
relate to your business.
Example: If your retail business bought
a $1,000 item and turned around to sell it for $2,000, then you have
made a $1,000 profit. But what if the buyer of the item is slow to
pay his or her bill, and six months pass before you collect on the
account? Your retail business may still show a profit, but what about
the bills it has to pay during that six-month period? You may not
have the cash to pay the bills despite the profits you earned on the
sale. Furthermore, this cash flow gap may cause you to miss other
profit opportunities, damage your credit rating, and force you to
take out loans and create debt. If this mistake is repeated enough
times, you may go bankrupt.
Analyzing Your Cash Flow
The sooner you learn how to manage your cash flow, the better your
chances for survival. Furthermore, you will be able to protect your
company's short-term reputation as well as position it for long-term
success.
The first step toward taking control of your company's cash flow
is to analyze the components that affect the timing of your cash
inflows and outflows. A thorough analysis of these components will
reveal problem areas that lead to cash flow gaps in your business.
Narrowing, or even closing, these gaps is the key to cash flow
management.
Some of the more important components to examine are:
- Accounts receivable. Accounts receivable represent
sales that have not yet been collected in the form of cash. An
accounts receivable is created when you sell something to a customer
in return for his or her promise to pay at a later date. The longer
it takes for your customers to pay on their accounts, the more
negative the effect on your cash flow.
- Credit terms. Credit terms are the time limits you set
for your customers' promise to pay for their purchases. Credit terms
affect the timing of your cash inflows. A simple way to improve cash
flow is to get customers to pay their bills more quickly.
- Credit policy. A credit policy is the blueprint you
use when deciding to extend credit to a customer. The correct credit
policy - neither too strict nor too generous - is crucial for a
healthy cash flow.
- Inventory. Inventory describes the extra merchandise
or supplies your business keeps on hand to meet the demands of
customers. An excessive amount of inventory hurts your cash flow by
using up money that could be used for other cash outflows. Too many
business owners buy inventory based on hopes and dreams instead of
what they can realistically sell. Keep your inventory as low as
possible.
- Accounts payable and cash flow. Accounts payable are
amounts you owe to your suppliers that are payable some time in the
near future - "near" meaning 30 to 90 days. Without
payables and trade credit, you'd have to pay for all goods and
services at the time you purchase them. For optimum cash flow
management, examine your payables schedule.
Some cash flow gaps are created intentionally. For example, a
business may purchase extra inventory to take advantage of quantity
discounts, accelerate cash outflows to take advantage of significant
trade discounts, or spend extra cash to expand its line of business.
For other businesses, cash flow gaps are unavoidable. Take, for
example, a company that experiences seasonal fluctuations in its line
of business. This business may normally have cash flow gaps during
its slow season and then later fill the gaps with cash surpluses from
the peak part of its season. Cash flow gaps are often filled by
external financing sources. Revolving lines of credit, bank loans,
and trade credit are just a few of the external financing options
available that you may want to discuss with us.
Monitoring and managing your cash flow is important for the
vitality of your business. The first signs of financial woe appear in
your cash flow statement, giving you time to recognize a forthcoming
problem and plan a strategy to deal with it. Furthermore, with
periodic cash flow analysis, you can head off those unpleasant
financial glitches by recognizing which aspects of your business have
the potential to cause cash flow gaps.
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We at
Small Business Accounting Solutions LLC, work closely with small business owners in Milwaukee, Waukesha, Racine and Washington counties. As a "one-stop-shop", we provide our clients with complete Accounting services, Business and Individual Income Tax preparation, Payroll services, Quickbooks training and more!
Small Business Accounting Solutions, LLC
1025 S Moorland Road Suite 500
Brookfield, WI 53005
Phone: (262)547-6000
http://www.sbasgroup.com
