Cash flow refers to the net amount of money or cash equivalents that your business receives or spends. Even seemingly well-run organizations are in danger of experiencing cash flow problems. Your business might have several assets on paper but still struggle to cover day-to-day transactions.
Cash flow is important because your company’s reserves should ideally keep rising to ensure long-term survival and growth. It’s crucial to regularly evaluate your current position and implement changes before it’s too late.
The Basics of Cash Flow
There are three essential types of cash flow. The first is operating cash flow, which refers to the money that your core business activities generate. The second is investing cash flow, which is the money you pay for investments and capital assets. Finally, the proceeds you receive from issuing debt, making payments, and selling equity are known as financing cash flow. A more general classification lists two broad types:
- Positive cash flow: It means your cash reserves are rising. This favorable position gives you the leeway to issue shareholder payouts, settle your debts, and re-invest in your company.
- Negative cash flow: This situation means you’re spending more cash than you’re generating. Your business cannot sustain a scenario in which total outflows are higher than inflows. Although you must acquire customers, improve distribution, and fuel growth, you must also avoid spreading yourself thin.
One way of tracking cash flow is through projections. Determine your cash on hand, add the payments you expect from customers, then deduct planned expenditures. The resulting figure should give you an accurate overview of your cash flow position.
There are seven essential drivers of cash flow. They are selling and expenses, accounts receivable, accounts payable, gross margin, revenue growth, inventory, and capital expenditure. We’ll discuss in detail how you can manage them to your company’s benefit.
Be Aware of Your Status
Calculating your current cash flow position is one of the best ways of evaluating your business health. There are three ways of achieving this objective: through free cash flow, operating cash flow, and cash flow forecast formulas. If you’re not conversant with these calculations, it’s advisable to hire an accountant or use accounting software.
A study of previous financial calendars helps you establish the high and low points that need your focus. You can accurately forecast which seasons are likely to have negative cash flow, then implement appropriate preventive measures.
Manage Variable Expenditures
Have a budget of all your expenses and their expected payment dates. You can easily plan for fixed costs such as rent, insurance, property taxes, wages, utilities, and interest. Variable expenses are harder to forecast. They include commissions, raw materials, credit card fees, advertising costs, billable wages, and shipping charges. These expenses won’t catch you by surprise if you have sizable cash reserves.
Put Your Cash to Work
Even as you build a cash reserve, ensure it works for you instead of lying idle. Uninvested funds tend to lose their purchasing power due to inflation. One way of avoiding this scenario is to put it in an interest-earning account.
You can also invest in money market mutual funds, certificates of deposit, Treasury Direct account, and bonds. These options provide attractive returns while allowing you to access your cash on short notice. Other uses for cash reserves are paying down debts, buying back shares, expanding operations, and buying strategic companies.
How to Survive Shortfalls
Even the most meticulously managed businesses have negative cash flow once in a while. You can do your best to forecast but still fall short. Avoid this scenario by arranging for lines of credit in advance to deal with unexpected cash crunches. Other options include:
- Ask for deposits or milestone payments for long-term projects.
- Encourage your customers to pay faster by offering them discounts.
- Delay or reduce expenses by hiring part-time contractors instead of full-time employees where necessary. You’ll save on administrative costs associated with full-time employees while improving overall productivity.
- Negotiate more favorable payment terms with your vendors. You can either ask for more extended payment periods or lower prices.
- Sell idle equipment and consider leasing instead of buying new machinery.
- Prioritize payroll first to boost morale and maintain productivity. Pay your primary suppliers on time as well, then set up suitable payment plans with other stakeholders.
- Improve your profit margins by reducing production and administrative costs. You may increase prices if you have a unique product with strong demand. Make sure to conduct proper research before implementing price hikes to avoid alienating some customers.
Consider Assistance from a Professional
Your key focus as a business owner should be on your core functions. Outsourcing the accounting aspect takes a heavy burden off your back. A professional accountant’s objectives go beyond achieving profitability. They’ll ensure you have a positive cash flow that guarantees long-term stability and growth. You’ll also gain from experience-based insider knowledge since they handle bookkeeping for various other businesses in your industry.