The term “cash flow” gets thrown around in business, but what is it exactly? Cash flow is precisely what it sounds like, the flow of money in and out of a business, and it’s one of the most essential measurements in accounting and finance. A business with more cash flow is always more successful because it can be less burdened by debt. A company without debt has more opportunities to grow by reinvesting cash and being more liquid (having the ability to pay off its short-term financial obligations).
The importance of cash flow management cannot be understated for businesses of any type. Whoever handles your company’s books, be it you or an accountant, should be producing a statement of cash flows either monthly, quarterly, or annually. The statement of cash flows shows what money has moved in and out of your business through operational, investment, and financing activities. Having a cash flow statement is essential for also having an accurate balance sheet and income statement.
A primary reason new business owners start to see negative values on their statement of cash flows is that they often confuse income with cash flow. According to its books, a company can seem to be doing great and have a lot of income at any given time. However, income is an accounting principle based on accrual properties, which align earnings to the time a product or service is delivered. Because of this, the company’s actual cash flow can be different from its net income.
If this is the type of thing that you try to stay out of while operating your business and let your accountant handle, that’s understandable. Unless it’s your chosen career path, not many people enjoy or understand accounting principles. Nonetheless, as a business owner, you must understand why your company needs to continuously work towards positive cash flows, other than the obvious reasons.
Here are some reasons why managing cash flow for your business is beneficial.
When a company’s cash flow is managed correctly, it has a clearer and more certain path to success. Through cash flow management, business owners can adjust their company strategy to bridge the gaps where cash flow projections might be missing the mark. Once a company becomes cash flow positive in all aspects (operations, investing, and financing), it becomes more liquid. Liquid businesses have more opportunities to reinvest their income into the business to achieve faster growth goals. Liquid companies are also more appealing to larger companies that may seek to buy out your business.
As mentioned before, when a business has cash on hand, you don’t have to worry about negotiating net 30, 60, or 90 payment terms. You can simply pay for goods and services upon receipt. By doing this, your company will achieve an excellent cash conversion ratio, which is essentially how quickly a business can convert cash outflows into cash inflows. For example, imagine you own a restaurant, and you pay your food vendors on receipt. That means any net income from food sales instantly becomes part of your cash flow since you have no outstanding liabilities.
For small and large businesses alike, maintaining a consistent marketing budget is a constant challenge. When companies are thriving and have extra cash, they tend to spend more on marketing. When times are tough, marketing budgets tend to be the first to see cuts, which is counterintuitive. By properly managing cash flow and ensuring that there is constantly cash on hand for marketing, companies will see a better return on their advertising spending, which means no more feast or famine which it comes to your marketing budget.
Although your company might be a long way away from being publicly traded, being a cash-heavy business can attract investors by paying dividends through its cash flow as a guaranteed return on their investment. Depending on your business type, you can also offer company shares to employees, which provide dividends, as part of an employee benefits package to attract top-level talent.
By now, it’s evident that properly managing your business’s cash flows is a crucial factor in allowing your business to grow. By carefully evaluating cash flow statements and making adjustments to expenses, accounts payable, inventory levels, capital expenditures, and other factors, a business can help increase its cash flow. Businesses with net cash on hand have many more opportunities for growth than debt-heavy companies with little to negative cash flow. If you’re having trouble managing your business’s cash flow, it’s a good idea to reach out to a financial professional for assistance.
- Why market research matters for your roofing business
- How to start a coaching business based on your unique skills
- How to effectively establish office management procedures
- Passive income vs. active income: What’s the difference?
- What is on-the-job training, and should your company offer it?