The Importance of Cash Flow

By Michael O'Brien - 30th Sep 2014

Find under: Small Business


 

Ignore cash flow at your peril; businesses that actively manage their cash flow have a far higher survival and success rate than those that elect to ignore it.
What is cash flow? Cash flow is the movement of money into and out of a business. In other words, cash flow is how much money is coming into your business from sales and how much money is going out on purchases, expenses and wages.

There is a business saying that says “revenue is vanity, profit is sanity, but cash is king”. It’s a common trap many businesses fall into, they confuse revenue with cash flow and end up in a situation where they don’t have sufficient cash to meet their immediate needs.

Another potential pitfall is the delay in invoicing for work done. Everyone knows that a sale isn’t a sale until you invoice your client. Invoice as soon as the work is done so that your business is not hit with negative cash flow problems, due to slow invoicing.

An example we often use is that of a busy restaurant. Suppose the restaurant is busy nearly every night of the week and suppose most of the customers pay by credit card. This is great for the restaurant’s profit figure. but what about  cash flow? With most credit card transactions there is a time delay between the customer paying and receiving payment from the credit card merchant. This time delay needs to be factored into the cash flow as it can have major consequences. Restaurants will usually buy fresh ingredients daily and suppliers will want payment in cash. Restaurants usually pay employee’s weekly too. So you can begin to see how a cash flow problem might arise. Delayed revenues combined with upfront payment can quickly put a growing business under cash flow strain.

Also, many businesses are seasonal in that they earn a bulk of their profits in a short space of time – tourism related businesses are a great example. It’s absolutely critical that they carry out cash flow analysis so they can understand and weather the “off peak” periods during the year when expenses and salaries will still need to be paid despite reduced income. Seasonal businesses might find that their monthly cash flow fluctuates from positive to negative during the year. The key is building cash reserves to enable you to keep operating as a business during times of negative cash flow. Don’t underestimate how important cash flow forecasting is to the ongoing success of your business.

In our Cash Flow Guide we list 8 best practice tips to managing and improving your cash flow:

  1. Plan: The first step to a good cash position is to be aware of what it will be. Forecasting your cash flow over the coming months will alert you to any possible issues ahead of time, allowing you to take preventative measures. Being aware of recurring revenues and outgoings is the first step.
  2. Invoicing: A sale isn’t a sale until it has been invoiced. If you wait 3 days to invoice your customers then 3 days have automatically been added onto the time it will take to receive payment. The quicker you invoice, the quicker you will get paid. Make sure that your invoice contains the necessary bank information and any customer required entries such as PO numbers. It should also be addressed to the right person to guard against any delays in payment.
  3. Identify Major Outgoings: By using your accounts to gather information on your business you should be able to see what outgoings are the largest. Is there room to reduce them without sacrificing your offering? Perhaps through bulk ordering?

Click here to download the Cash Flow Guide and get all 8 tips plus our Cash Flow Checklist.

 

 

 

About the Author: Michael O'Brien

Michael is the marketing manager for Big Red Cloud. Apart from trying to demystify accounting software, Michael enjoys rugby, photography, good food and seeing as much of the world as possible.