Just how amazing is your company’s financial health? Is it rocking like a rock star? Check your cash flow. Wait, hold on. What is cash flow in a small business, you ask? Well, do you have a steady flow of customers spending and providing you with constant cash? Do you have more funds coming in than going out? With one, you’re doing pretty good, and with the other, you’re going to end up closing your doors for good. Probably sooner rather than later.
But, OK. The technical definition provided by the Merriam-Webster Dictionary says that cash flow is “a measure of an organization’s liquidity that usually consists of net income after taxes plus noncash charges against income.”
Investopedia says it better: “Cash received represents inflows, while money spent represents outflows.” In super simple terms, it’s just the movement of cash into and out of your business. Sheesh. We can break it down in better fashion than the dictionaries!
Now, other factors also determine your business’s financial health, but we’re focusing on cash flow in this article. We’re going to go over the nitty-gritty as to why cash flow should be something your small business considers, no matter how new (or established) you are.
Let’s begin, shall we?
Positive cash flow is vital because if you don’t have it, there’s a high likelihood that your venture will fail. If you don’t have cash coming in, you run out of money, and your company bites the dust. In fact, according to CBInsights, 29% of businesses that fail do so because their executives don’t have a proper understanding of cash flow or how to manage it. (e.g., they ran out of cash.)
When starting a business, dealing with cash-flow issues can be difficult. In fact, the first six months can make or break a company because many suppliers won’t give you credit. Moreover, money usually goes out faster than it comes in. There are tons of expenses, and gaining customers may be slow going until your marketing ramps up. Many business owners take out lines of credit to tide them over until they reach a point of positive cash flow where there is more money coming in than going out.
Most small businesses bring money into their accounts by selling a product or service. As they grow, they add more products and services to their offering lineup. In many instances, cash flow isn’t consistent all year long. That’s especially true for businesses that are seasonal in nature, such as pool-cleaning services, gardening companies, or lawn-mowing services.
To maintain a positive cash flow, many business owners take out small-business loans or invite investment so that they have a constant supply of cash to cover expenses. Another way of helping to maintain a positive cash flow is to completely cut out all nonessential purchases and costs.
There are just a few specific ways to manage your cash flow so that you avoid financial emergencies, which include:
- Control your inventory: Keep track of your inventory because having too much ties up your cash.
- End relationships that aren’t profitable: If you have a customer who never pays or is consistently late on payments, do not continue doing business with that individual.
- Pay attention to your cash-flow statements: You’ll have a good idea of where you are during the month.
- Collect receivables by setting up a schedule for collections: Always follow up with those who are late on payments.
While many businesses fail due to a lack of positive cash flow, your company doesn’t have to be in that number. If you have to, get help. Taking out a line of credit that you can draw from in times of need can be a smart move.
Keep in mind that business credit lines don’t work in the same way that loans do. With credit lines, you have a credit pool that you can draw from when needed, and when you have more money on hand, you pay back whatever you took. The interest you will owe is only on the amount you take out. For instance, if you have a line of credit that goes up to $50,000 and you take out $20,000, you’ll only owe interest on the $20,000 that you withdrew.
A best practice, however, is to be wise from the very beginning. Before you ever open your doors for business, try to ensure that you’ve got two to six months of operating expenses set aside as cash reserves in a business-savings account. By doing so, you’ll be protecting your company. You’ll have the added benefit of having some peace of mind knowing that your company has a fighting chance to survive its first year in business.
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