Managing cash flow important to success
Oct. 26, 2010 at 5:26 a.m.
Cash flow to a business can be a sign of its health or its pending failure.
Simply put, cash flow is the money coming in to a business as well as the money going out. This includes everything from sales dollars to expenditures for office supplies.
By understanding the importance of cash flow, small business owners and entrepreneurs will be far ahead of the game.
At the beginning of the cash flow cycle, most businesses start with - you guessed it - cash. From that point on, the central purpose of the business is to convert that cash into other kinds of assets, or to extend it with liabilities and ultimately turn it back into cash again. Only this time, the business wants more cash than it started with.
This process continues throughout the life of a business.
The concept of cash flow, meanwhile, can be defined in different ways. Some people think of cash flow as an income through sales, revenue through any economic activity or any expenditure for the organization.
Cash flow is any kind of income or expenditure that affects the cash accounts. A cash flow must be strictly, financially liquid cash or finances that can be stored in a bank account or in the form of currency. Any financial statement that shows an inward or outward flow of cash is proof of cash flow.
Cash flow can be broadly divided into two categories - inflow and outflow. The cash inflow, which is also known as inward cash flow or just cash flow, is generated as a result of financing and/or sales. The cash outflow is a result of many factors such as purchases, investments, salaries and any other expenses.
Following are some advantages of inward and outward flows of cash.
Debt avoidance. The timely cash inflow plays a very important role in keeping you out of debt, as a timely inflow of cash helps to decrease the need of loans.
Unnecessary spending. The use of inward and outward cash flow helps to prevent all unnecessary expenses such as piled up interest, late payment charges, etc.
Timely payments. The uniform and assured cash flow, in both the directions, helps to ensure timely payments of salaries to employees loan installments. This ensures the trust of employees and upholds your credit rating.
Sometimes your business budget will show you make more than you are spending and life should be great. The problem is that sales tend to be irregular while your bills are consistently due at the first of the month.
Suddenly, having enough money every month on paper doesn't seem to feasibly work. You have consequently entered a never-ending cycle of playing catch up with your expenses and income.
Cash flow enables you, the business owner, to plan for those times when sales are not steady. Building up a sufficient flow of cash to ensure your business can account for times of the month in which expenses are higher than others can take time.
There are some simple fixes to help, such as working with your vendors to change payment terms from due on receipt to due 30 days from order receipt. This gives a business time to sell the product that they have purchased and frees up cash while building sales.
The interesting thing about cash flow is that we tend to not pay attention to it until suddenly we are behind on all payments and don't know when the next sale will happen to cover the debts.
Understanding the welfare of your business requires more than looking at the total dollars coming in versus the total dollars going out. More times than not, poor cash flow management will certainly cause business failure.
Kacey Lindemann is a senior business advisor for the University of Houston-Victoria Small Business Development Center.