Cash Flow

Cash flow management can be complex for small business owners. Often, the average small company only has enough cash to cover one month of expenses. This is far less than the three to six months that most financial experts advise. Understanding how cash flow works can help you budget and pay company expenses if you’re a small business owner. It can also keep your cash flow calculations on target.

How Cash Flow Works

Cash flow represents money moving in and out of your business. A business with positive cash flow brings in more than it pays and vice versa. In addition to cash, “cash equivalents” are also included in cash flow calculations because they are liquid assets, and you can easily convert them to cash. These items consist of marketable securities, commercial paper, and short-term bonds.

There are different types of cash flow, including:

  • Operating
  • Financing
  • Investing
  • Free

Operating cash flow is the money that you generate by conducting business on a day-to-day basis. This does not include investments or other income sources. If you subtract assets from your operating cash flow, you create free cash flow, the amount of money accessible to creditors and investors.

A cash flow ratio shows how the funds that come into your company relate to the business expenses, debts, and sales. Therefore, knowing your company’s cash flow ratios can determine whether it can pay its debts.

Understanding a Cash Flow Statement

A cash flow statement is one of three financial statements that report a company’s cash generation and spending during a particular period. This statement acts as a “bridge” between the company’s income statement and balance sheet by showing how funds moved in and out of the company.

Cash flow statements include three key sections. These are the:

  • Operating activities
  • Investing activities
  • Financing activities

Operating Activities

Operating activities represent funds from a company’s operations. You determine operating activities by taking the business’s operating income plus non-cash expenses minus the sum of tax obligations and changes in the working capital.

Investing Activities

Investing activities represent any activity outside the ordinary course of business that could impact cash flow. For example, buying and selling property or equipment are investing activities.

Financing Activities

Financing activities represent the investment(s) you make in the company, plus money from other funding sources like venture capitalists, angel investors, bank loans, or funds from family and friends (for the business).

When you add the figures from all three of these activities and expenses are deducted, you will get the total for the cash and cash equivalents for the company during a particular time. Many business experts recommend that you prepare a cash flow statement monthly. That way, you can clearly see how much the company earns and spends. Doing so can also create a regular and ongoing record of your business’s financial health.

You can also more easily determine where your company needs better cash flow management strategies. In addition, if you need capital from lenders or investors, the cash flow statement can show them how much risk they may take on by loaning or investing funds with the company.

It is important to note that cash flow and net income are different. Net income includes sales your company made to customers on credit. In this case, if funds from those sales have not come in when preparing the cash flow statement, you cannot count it as available cash.

Creating a Cash Flow Plan

Cash flow analysis is another essential component of your company’s money management because it can help you determine potential problems with funds moving in and out of the business. It can also show you where the issues stem from. This can allow you to catch them early and take immediate steps to correct them.

The main areas of cash flow analysis include:

  • Accounts receivable
  • Accounts payable
  • Shortfalls

Accounts receivable represent your company’s sales but have not been paid for yet. In contrast, accounts payable is the total amount of money your business currently owes to its vendors and suppliers. Therefore, if your company has a shortfall, it has a liability that requires more cash than the business presently has.

You can consider cash flow analysis a “snapshot” of the company’s present cash flow status. While it doesn’t provide as much detail as a full financial statement, cash flow analysis still allows you to determine whether or not the company’s finances are on track.

Items to Consider When Managing Your Company’s Cash Flow Status

Cash is often considered the lifeblood of a business. When you have all the cash flow figures on hand, you will be in a better position to make various financing decisions. Some important items to consider as you work on your company’s cash flow management can include the following:

  • Determine the number of products or services your business must sell to break even (based on your intended profit margin)
  • Learn the difference between cash flow and profit
  • Maximize efficiency in your company’s sales process
  • Improve your business’s invoicing strategies to reduce the amount of time between billing and payments
  • Decrease your company’s liabilities via debt and expense management
  • Attain and maintain a cash cushion

You should also be mindful of factors that could throw off your cash flow calculations, such as:

  • Equipment malfunctions
  • Loss of one or more key customers
  • More demand than you anticipated for a new product launch

Does Your Business Have Ample Cash Flow?

If your business is struggling with ample cash flow, or you’re seeking a better way to manage your company’s income and outgo, a cash flow specialist can help. Once you have a process in place, you can more easily track money moving in and out of the business and more confidently set short- and long-term goals.

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