Today we will talk about a crucial topic for small business owners. It helps your company to manage your money better. It is called Cash Flow.
Most small business owners manage their money by looking at their bank account balances. It may distort the company’s financial health because if they don’t see that bills are coming, you might spend the money on other things, and when the bills’ due date arrives, they don’t have enough cash to pay them.
What is Cash Flow?
Cash flow (CF)is the cash that comes in and goes out of the company. A business receives money from sales as revenue. Also, it may obtain cash from interest, loans, and shareholders’ investments. And a business spends money on expenses, such as materials, employees, office supplies, and everything else to keep a business running. The objective is to assess the amount, time, and future uncertainty. It is essential to evaluate the company’s performance and health.
It is necessary to track the money daily, weekly, or monthly so you can make a faster decision to fix a problem. As soon as you find a gap, you will be able to fix it. Tracking helps you to avoid a situation such as, for example, you had a week in which you sold more than usual, so you may think it was a good week, but your clients will pay you later. Then, you discover that you don’t have money to pay your expenses that week. As you keep your records updated, you were able to identify this situation early so that you could have charged your clients upfront to cover your expenses.
Positive cash flow allows you to reinvest in your business, pay back the shareholders, and reduce business risk. It can be analyzed using the cash flow statement, forecasting, and free cash flow. Investors, business management, and analysts use them to determine how well a company performs.
Types of Cash Flow
Cash Flow Statements are divided into operating, Investing, and financing.
Operating Cash Flow
It shows if your business operation generates enough cash to cover the operation’s expenses. Business operation means sales from your core business minus the costs to produce the sales. For example, if you have a construction company, the operating cash inflow is the job you deliver, and the costs are the material, employees, and subcontractors. It indicates whether a company can generate enough cash to maintain and expand operations or whether a company needs external financing. Then, to be sustainable, your operating cash inflows must be more significant than your cash outflows.
Investing Cash Flow
It shows how much cash has been spent or generated from investment-related activities, such as buying a new warehouse or equipment; receiving money from sales of property and equipment.
As a business, investing a lot of cash in fixed assets, such as buildings, equipment, and servers farms, may cause a negative investing cash flow. Depending on the stage of a company, it’s not bad.
Financing Cash flow
It indicates how a company finances its capital. Financing activities include borrowing money from lenders, repayment of borrowing, dividends, and repurchases of stocks. It provides information on a company’s capital structure.
Example: Amazon.com CF
Cash Flow Forecasting
It indicates how your money flow will be in the future. Based on the previous events, the Chief Financial Officer or the Financial Manager can project how the receivable and payable will look.
The three objectives of Cash flow forecasting are:
- Anticipate upcoming cash gaps and be prepared for them.
- Reinvest in your company with the extra money
- Stress less about your company’s future.
Once you have done it, it is vital to go back quarterly and compare the forecasting to the actual cash flow for the period. By doing so, you can identify the reason for this difference and make adjustments if necessary. Doing it can show you upcoming cash gaps, then you will have time to find a solution. You will be prepared for it. For example, suppose you have a seasonal business. In that case, you know the part of the year you don’t have much cash coming in. So, one solution is to cut your expenses for that period or save money when you have the highest amount of money coming in.
This example shows the difference between a company that lasts for decades to a company that closes before five years.
Another benefit of it is reinvesting the extra money in your company. By managing your cash well, you will have a cash surplus. So, you can allocate this money to different places. You can pay yourself more or choose to grow your company, and you need to spend money on hiring people, new equipment, a new warehouse, or new software to improve your production. It is important to have a prepared company for the future’s uncertainty.
Free Cash Flow
Free cash flow projects how much a company generates cash after spending money on Capital Expenditures, taxes, and business operations. Investors use it to evaluate a company. So, the more free cash flow a company has its value increases.
3 Ways to improve your cash flow
To improve your CF, you must include it in your daily routine because having a good process; requires discipline, organization, and consistency. Here are the three ways to improve it:
1 – Having a system
You must have a process to do your cash flow daily. You can do it on a spreadsheet or software, but you must input daily how much cash comes in and goes out.
2 – Project your cash flow for six weeks
Project it for the next six weeks based on your receivables and payables. Also, you can make an average for the other expenses, for example, insurance, gas, subscription, and office supplies. By doing that, you can predict what might happens in the future. So you can make a fast decision.
3 – Compare your cash flow forecasting to your actual every week
Comparing your projection to your cash flow allows you to identify what is not going as planned. Sometimes something happens without any expectation. For example, if a machine breaks or your vehicle is damaged, you must spend money fixing them. That amount of money is not in your projection. That is why keeping a percentage of your projection to unexpected expenses is essential.
Conclusion
Cash flow is one of the most important tools to manage a business because, without money, your company will go bankrupt. Positive cash flow allows you to reinvest in growth and pay more for the shareholders. Project it so that you can find any cash shortage. And build a process to take care of it daily. Doing that will reduce the risk of struggling to keep money in your business.
Contact us if you want to do or improve it to grow your company.
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