Anybody who is in to business knows that cash flows are the main ingredient for a business’ survival. Opinion is divided amongst business experts regarding what’s more important for the business to thrive in the industry; the ability of the business to deliver goods and services, or to generate healthy cash flows. Even though this might seem unnatural, consider the fact that if one customer is displeased and takes his business elsewhere, you can always try harder to please the next one. However, if you don’t have enough cash in order to pay your employees, creditors or suppliers, your business is likely to come to an end.
What is a Cash Flow?
In the simplest of terms, cash flow refers to the movement of money coming in and going out of your business. These are also known as cash inflows and cash outflows. As you can expect, cash inflows are generated when sales are made of goods and services to customers. However, it should be known that only sales made in exchange for cash are counted as inflows, or a collection is made of the receivables. It is the cash that matters. There are other examples of cash inflows as well; such as borrowed funds, income that is generated by selling off assets as well as the additional income generated from interest.
On the other hand, cash outflows occur when you pay cash to cover business expenditure. There are numerous examples of cash outflows, such as the payment of employee wages, purchase of raw materials or inventory, purchase of fixed assets, payment of operating costs, repayment of loans as well as payment of taxes.
[learn_more caption=”Note:” state=”open”] Note: If you want to know how your cash flow statement works, the most qualified person you can get in touch with is an accountant. Please get in touch with us and we can help you prepare your cash flow statement as well as provide you clear insight regarding the formation of the numbers.[/learn_more]
Cash Flow versus Profit
Even though they seem similar, there is a marked distinction between cash flows and profits, and both of which provide different results/ views on the performance of the business. Profit generally encompasses a greater number of elements, and covers a certain period usually, such as a fiscal quarter. Profit is a very useful item however, as it helps you calculate taxes that need to be reported to the IRS.
On the other hand, cash flow is a very different term, one that holds a significant amount of meaning for the daily operations of a business owner. Cash flow is related to the movement of money in and out of the business. Importantly, cash flow also takes in to account the periods in which the money moves in and out of the business.
Theoretically, every company that is generating profits can go bankrupt. Obviously, significant amounts of negligence and utter disregard to cash flows will be needed for that situation to materialize, but it is possible. Let’s consider how cash flows and profits are different when they are connected to your business.
[learn_more caption=”EXAMPLE” state=”open”] Example: If you purchase inventory for $1,000 and manage to sell it off for $2,000, you are generating a profit of $1,000. But, what happens if the buyer purchases the item on credit, and pays money six months after the purchase was made? Your retail business is still showing a profit, but since no cash has flown in to the business, how will you be able to pay the expenditure incurred due to the running of the business over the period of the six months? Even though you made a profit on the sale, you don’t have enough cash in your coffers to pay off your bills. Now, ultimately, this delay in the inflow of cash might also make you miss out on further profit generating opportunities. It can also damage your credit rating, and ultimately force you to take out loans and increase your debt. Repeat this mistake over and over again, and your business will go bankrupt sooner than you know.[/learn_more]
Analyzing your Cash Flow
For business owners, it is important to learn how to manage their cash flows, as that will significantly improve their chances of survival. Moreover, you will also be able to improve the position of your business in the short term, ultimately enhancing its reputation in the long run too!
The first thing that you can do in order to take control of your business cash flow is to understand the components that have a direct impact upon your cash flow statement. Once a careful analysis of these elements has been carried out, you will know the areas that are causing the most problem in your cash flow statements. Reducing or completely closing these gaps is important to the proper management of your cash flows.
Here are some of the most important components of the cash flow statement:
Accounts Receivable: Accounts receivable are simply sales that have been made, but cash on which has not been collected. These are registered as assets on your business’ balance sheet. You create accounts receivable when you sell anything to customers on credit; the payment on which will be collected on a later date. The longer it takes for your accounts receivables account to be cleared, the more negative will be the impact on your business cash flow statement.
Credit Terms: These are the time limits that you can set on your customers to clear their dues for the purchases that they have made. These inflows impact your cash flow statement. A simple way to improve your cash flow statement is to ensure that your customers make their payments quickly.