One of the primary business metrics we make sure to measure for our clients is cash flow. This is because cash flow can really make or break a business.
It is the difference between a business growing and a business going out of business.
Some 82% of businesses that fail, as is described by Jessie Hagen of U.S. Bank, have mismanaged or misunderstand their cash flow. But, why is it so hard to manage? What is the difference between profit and cash flow? How do you manage cash flow?
Let’s get started!
What is Cash Flow?
Simply put, it is the amount of money (or cash) moving in and out of your business every month.
This can be either from immediate cash transactions, e.g. your customer handing you cash or the cash being deposited into your account or you paying a vendor in a similar manner. We can break this down into Accounts Receivable and Accounts Payable.
Accounts receivables are your outstanding customer payments. This could be something like a charge account for frequent customers. This needs to be factored into your cash flow assessments.
Accounts payables are the amount of money you have due for expenses such as your rent, loans, taxes, etc. These are the big cash withdrawals that your business has to prepare for in order to stay in the black.
Ultimately, you’re going to want to have a “positive cash flow,” meaning that you have more money coming in than going out. Most importantly, you will need to avoid overdrawing on your account or losing your building, etc. if you run out of money.
This is where cash flow management becomes important!
Why do I Care?
Every month you need to have a clear idea of what expenses need to be paid in order to keep the business open.
If you know that you have a big, necessary payment coming up on something that cannot be put off (say, sales tax, for example) it might not be the correct month to do aesthetic office improvements.
The Balance describes this importance well. It says, “Lack of cash is one of the biggest reasons small businesses fail. The Small Business Administration says that “inadequate cash reserves” are a top reason startups don’t succeed. It’s called “running out of money,” and it will shut you down faster than anything else.”
Cash flow, they note, is especially important in seasonal businesses. If you sell knitted Christmas stockings, you really only have one busy period, but you need to be able to keep the necessary business components running all year round so that when winter rolls around you’re ready.
What is the difference between Profit and Cashflow?
Confusing profit and cash flow is a frequent business owner mistake. A successful business will need to have positive profit as well as positive cash flow.
Profit is the amount of money earned after all expenses are deducted. Cashflow is the amount of money on hand at any given time, and thus good to spend, going forward. To avoid being “cash poor” you need to make sure that spending priorities are well aligned.
One of the most common situations in which a profitable company can have negative cash flow is with businesses that deal with inventory. The business may need to buy large quantities of inventory at a time – which reduces their money or cash on hand. As they sell the inventory, they may have a healthy profit margin, but they still must sell off the inventory before that profit is realized.
If you are still confused about the difference between profit and cash flow, Inc.com writes a great article that gives examples of how “profits and cash flow can exist in varying degrees of balance.”
Maintain Cash Flow Balance
- Monitor Cash Flow – it is important to be pretty frequently aware of where you stand with your cash inflow. We always send our clients a cash position report before bill pay so that they can understand what certain payments will do to their business cash standing.
- Focus on Cash Flow Over Profits – Quickbooks provides a great assessment of this issue. They write that business owners should “use [their] breakeven point as a benchmark. After [they] reach breakeven and [the] business is profitable, [they] still need to manage… cash flow… [then they] have reached another stage of… business life.” By focusing on cash flow, the business owner can ensure they are around for the long run. Be careful with those inventory purchases!
- Collect Accounts Receivables Quickly – The faster you can get the money owed to you by your customers in your bank account the better! Invoice quickly and effectively and make sure to follow through if there is a lag in payment.
Ready to Grow!
Following these simple steps will help to get you on the right track to avoiding common cash flow errors. And, for your business, this can mean life or death.
P.S. If you need help monitoring your business’s cash flow you can always schedule a meeting to get started with the best bookkeeping team around! 😉