Cash Flow: Why Is It So Important?

Why is Cash Flow important?
Cash flow is one of the most important concepts when it comes to your business. That is why our weekly articles this month are on the topic of ‘cash flow’ which comes under the Administration and Finance pillar of business success.

You need cash coming in so you can pay bills, buy inventory, pay employees, and of course, pay yourself as well.

At its simplest meaning, cash flow is the total amount of money that comes into and goes out of a business. In other words, it’s the money that keeps on flowing through a business and the money coming in must exceed the money going out if the business is going to survive.

Tracking Your Cash Flow

That is why tracking your cash flow is critical to any business.

The money coming in includes things like …

  • clients paying you for work,
  • customers paying for your products,
  • rent you receive for property you own and rent out,
  • interest earned on interest bearing accounts.

If you have a business that operates online, you may also have money coming in from:

  • affiliate commissions you receive for promoting other people’s products,
  • advertising revenue,
  • residual income for books you’ve written,
  • and so on.

Think of all this money flowing into a bucket.

On the other side, money also comes out of the bucket to cover your expenses and your salary.

  • The phone bill you pay every month,
  • the assistant you hired,
  • the office you’re renting,
  • the new computer you just ordered,
  • your advertising,
  • your inventory,
  • and so on.

These all come out of company funds. As a business owner it is your responsibility to make sure those expenses are covered.

Your Cash Flow Goal

Your cash flow goal should always be to have a positive balance between money coming in and going out. You don’t want to continually spend more than you have coming in. Your ‘bucket’ would run dry quickly, putting you out of business.

At the same time, you don’t want a bunch of money just sitting in your business. It doesn’t do you much good there. Yes, you need a safety cushion to help you through some lean months, but as a general rule, you want to either reinvest a portion of your profit in the business or take it out to invest in something else.

Cash flow is a money management tool for you, as well as an indicator of how well your business is doing. It also helps you plan what you can spend down to the road to expand your business, upgrade equipment or give yourself a raise.

If you’re not already keeping track of this vital measurement, now is the time to start doing so. It’s a powerful tool to have in your belt and one of the best ways to make sure your business stays viable and profitable for years to come.

In every business there is a cycle whereby cash invested in the business goes through a number of steps, before it converts back into cash again (hopefully more cash than we started with).

Cash flow cycle

Management of cash flow involves focusing on the stages of the cycle that apply to your business, to ensure that cash is moving through the cycle, and not being tied up unnecessarily at any stage.

Time Is Money!The longer money is tied up in inventory and/or accounts receivable, the more costly and greater the cash flow problems of a business.

Negative Cash Flow Survival Tips

No matter what you do and how careful you plan, chances are that there will be times where you end up spending more than the money coming into your business. In other words, you’re going through a period of negative cash flow.

It happens to all of us. What’s important is how you deal with it.

Here are some tips to help you make it through the lean times and keep the business alive.

Be Prepared with a Financial Buffer

An ounce of prevention is worth a pound of the cure.

The same holds true for cash flow problems. You won’t have to worry about generating more income if you have a bit of a financial buffer in the bank account.

Think about your operating expenses and then come up with a figure that would help you make it through a “Cash Flow Drought”. Then set aside 2 to 5 percent of your monthly profits to build up that safety cushion.

You don’t want to burn through the savings you’ve set aside too quickly. As soon as you start to notice that your expenses are higher than your income for the month, take a look and see if there’s anywhere you can cut back. Don’t make any purchases that aren’t absolutely necessary. If you know this is only a short-term problem, talk to your suppliers to see if you can push back payments for a few weeks.

Next take a close look at your accounts receivable. Look for any customers that have been billed but have not yet paid. Give them a call or send them a quick email reminding them that the payment is due.

Communicate With Your Customers/Clients

Let’s talk about using emails.

This is a great time to email your existing customer base to remind them about your products. Often just a simple email will drum up some extra business in time of need.

If you don’t think this will generate the cash you need to make it through this financial bottleneck, consider running a sale or making them an offer that will be hard to refuse. Throw in a free consultation, come up with a bonus, or offer a discount to anyone placing an order in the next 48 hours. You know your customers and know what will make them get out their wallet and buy.

Once you make it through the period of negative cash flow, go back and figure out what caused it in the first place.

What can you do in the future to avoid a similar situation?

Last but not least, don’t forget to rebuild your financial safety cushion once things are back to normal.

10 Ways to Improve Small Business Cashflow

This article is one of a series on the topic of cash flow. Here are links to the other articles in the series:

The Difference Between Cash Flow and Profit
Cash Flow: A Two-Sided Coin
6 Tips to Understand Cash Flow

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