“Revenue is vanity, profit is sanity, but cash is king.”
Whether you own a small business or a start-up, the phrase above is accurate to all companies. It’s true that a company could be profitable but have no cash. Without enough funds to maintain its daily operational needs, even a profitable company could go out of business.
The single most crucial aspect of running a business is cash flow management. However, cash flow is often confused with profit, so it’s essential to know its definition and why it matters for your business.
Cashflow 101
Cash flow is about the money that goes in and out of your business.
Cash inflow – is the money that is going into the business. The cash received for goods and services, interest/dividend received from loans and investments.
Cash outflow – payments to suppliers, payroll costs, and other results of expenses and investments.
Factors that affect cash flow include:
Operating activities – cash that goes in and out as a result of doing business (e.g. customer receipts, supplier payments and wages)
Investing activities – include cash involved in purchasing assets (e.g. office equipment) or money received from the sale of assets or any other investments.
Financing activities – refers to loan repayments or loans received from a lender and any money taken in and taken out by the business owners.
Cash flow can either be positive or negative. A positive cash flow indicates that the business’s liquid assets increase, which means it has enough cash to cover its expenses and grow or make investments. On the other hand, a negative cash flow means your company is spending more than it receives.
A company could incur negative cash flow from investing activities or expansion, which is not always bad. However, it becomes a huge problem when the business can no longer cover its expenses and loses money due to poor cash management. Keeping an eye on your cash flow statement is vital.
(Also Read: Improving Your Cash Flow: Tips for Small Business Owners)
Cash Flow Statement (CFS)
If you’re already running a business, you probably know that the cash flow statement is one of the most significant financial statements. The others are the income statement and the balance sheet.
The cash flow statement summarises the cash that goes in and out of business. It tells you how much money your company has on hand for a specific time. This report allows you to gauge how well your business is generating cash to meet its obligations.
The CFS is also helpful with budgeting, as you can use this to predict future cash flow.
This financial statement also tells you and your investors where your money is coming from and spending it. It shows how much cash the company generates and gives them an overall understanding of your business’s financial health.
Using accounting software, you can produce the CFS based on the data you entered in the general ledger.
You can also create cash flow forecasts using apps that can integrate into your accounting software.
Why Monitoring Cash Flow Matters
Identify How Much Actual Cash You Have
Even if a company may seem profitable, it doesn’t mean that it will not go bankrupt. Poor cash flow can lead to a failed business.
For example, a customer just ordered $50,000 worth of products from you and will pay this in 60 days. However, you need to purchase $30,000 of supplies from your vendors to produce that order, which you pay in 30 days. Within those 30 days, you also have $25,000 worth of bills to pay for rent, utilities and payroll. If you don’t have enough cash, you will fail to pay your supplier, resulting in upsetting your vendors and facing penalties for late bill payments.
By closely monitoring your cash flow, you will know exactly how much money you have at any given moment. You will see if you have enough money for your business and meet your obligations. It will tell you if you need to inject more money into the business and chase outstanding invoices if there are any.
Maintain Good Business Relationships
If you have poor cash flow, you may have trouble paying your suppliers on time, which negatively affects your business with your vendors, ultimately affecting your reputation.
By tracking your cash flow, you exactly know when payments are due, and if you don’t have enough cash to meet your obligations, you can make adjustments beforehand or negotiate new payment terms with your suppliers.
Use as Basis of Important Business Decisions
By looking at your cash flow statement, you will understand how your business is performing. If you see a good amount of money coming into the business, maybe it’s the right time to pursue growth and expansion. Or, if you know that you don’t have money available to fund your plans to grow, you know that you need to slow down and re-assess how you can improve your cash flow or get funding where you need it.
Manage Cash Flow Better
A regular review of your cash flow statement will show you if you need to control your expenses or increase the cash coming in. One way to improve cash flow is by keeping a close eye on your accounts receivable.
(Also Read: How Financial Reporting Can Change the Game for Your Business)
Remember that the only way to create an accurate cash flow statement is when your accounts are accurate. Having a VCFO on board can assist your business in managing your cash flow.
If you need assistance with bookkeeping or need advice from a VCFO on managing and forecasting your cash flow, don’t hesitate to contact us.