Understanding cash flow management and comprehending why is it essential to the success of small businesses are two topics surprisingly few entrepreneurs and professionals fully understand. In order to predict revenue streams or restructure financial practices to achieve company goals, having a good handle on cash flow management is essential. Whether an organization invests time and energy into cash flow analysis utilizing cash flow management tools or outsources its management, intelligent decision-making improves the financial health and well-being of an organization.
What is Cash Flow?
A business’s cash flow involves the amount of revenue moving in and out of an organization. Revenue streams include cash and cash equivalents in the form of payments for products and services, accrued interest, royalties, and licensing agreements, among others.
Tracking cash flow amounts and trends helps business leaders predict profitability and plan for financial shortfalls. Cash flow is also a primary metric in determining the financial health and stability of an organization.
There are also subsets of cash flow that describe where and how revenue is generated and spent. Cash flow from operations speaks to revenue generated from the ordinary course of operations. Transactions involving the sale of goods, materials, and services generally fall under this heading. Cash flow from investing stems from the strategic use of company assets and money. Assets are purchased, and the money gained when they are sold falls into this category.
How to Calculate Your Cash Flow
A misconception persists that cash flow and profit are basically the same thing. That may be due to the fact that cash flow involves money that moves in and out of the company. But profit speaks almost exclusively to the money retained by a business after all of the expenses are paid.
Cash flow doesn’t necessarily highlight profitability or financial success. Rather, cash flow statements help entrepreneurs and industry leaders make informed decisions about short- and long-term liabilities and overall liquidity. After calculating various types of business income and the anticipated expenses, a clearer picture emerges regarding cash on hand at various points.
Positive cash flow generally shows that a business can pay its bills with profit left over. When expenses exceed incoming revenue, a state of negative cash flow exists. Industry leaders may need a fallback position when revenue streams are predictably lower than expenses.
Manage Your Cash Flow Better With These Tips
It’s essential to keep in mind that cash flow statements are not designed to serve as a passive metric. They are more akin to a roadmap guiding captains of industry toward a destination. At any juncture, leaders can decide to change course. These are ways business leaders can modify practices to maximize cash flow.
1: Forecast Your Inflows and Outflows
One of the key benefits of establishing ongoing cash flow processes is predictability. Over time, trends emerge that point to increases and decreases in revenue. By that same token, outgoing resources highlight monthly, seasonal, and annual liabilities.
A careful cash flow analysis allows companies to plan for financial peaks and valleys. As long as all things are relatively unchanged, capital improvements, inventory stockpiling, and hiring skilled personnel can be included in a financial forecast. And when outgoing money is expected to exceed income, strategies can be implemented to navigate shortfalls.
2: Manage Your Invoices and Bills Strategically
It’s not uncommon for newly minted enterprises to prioritize bill paying. While noble and a sound credit-building practice, sometimes business bank accounts dip dangerously low. Small and mid-sized startups require enough cash on hand to cover unanticipated expenses and take advantage of opportunities.
By extending payables and spreading out payments, the organization maintains a healthy cash reserve. Consider paying the most important expenses first and rank the others based on priority. This is not to say pay late, just avoid allowing business bank accounts to dry up.
Explore how to start, expand, or manage your business in Massachusetts by downloading our free guide:
3: Adjust Your Inventory
Another critical insight a cash flow assessment provides is knowing when to grow and shrink inventories. Revenue associated with product sales or services is inextricably linked to inventory. These may include raw materials used in manufacturing, wholesale products to be sold at retail prices, or resources needed to carry out professional services.
The point is that companies can make strategic inventory investments at key junctures, knowing they will experience a profit-driving turnaround in the near future. When seasonal lulls are expected, it may be more cost-effective to reduce inventory expenditures accordingly.
4: Lease Equipment Instead of Buying It
The monthly cost of leasing equipment is generally lower than the cost of a loan. Some argue that purchasing equipment builds the company’s assets and value. While that may be true, a cash flow analysis offers another way to look at equipment.
Keep in mind that the cost of equipment becomes a pass-through expense businesses must recoup from customers and clients. That generally drives up the cost of goods and services, making the organization slightly less competitive. By that same reasoning, the lower price of leasing equipment helps decrease pass-along costs. It’s also important to note that buying hits the balance sheets a tad harder than leasing.
5: Borrow Before You Need It
There is a wide range of business loan products that can help companies navigate cash flow slowdowns or invest in an expansion. Loan products backed by the Small Business Administration (SBA loans) provide competitively low-interest rates and favorable terms. Those interested in acquiring a business space or updating an existing facility typically apply for a commercial real estate loan or a short-term bridge loan in some cases. The essential point is that qualified businesses have access to commercial loan products to accomplish goals without depleting resources.
6: Structure Payroll Correctly
The traditional weekly payroll cycle doesn’t always jibe with revenue streams, which can result in uncomfortably low bank accounts. Not every operation experiences smooth revenue streams that swell business bank accounts on a daily or weekly basis. That’s why it may be advantageous to set up payroll cycles that cut checks every other week or once monthly.
Consider reviewing your cash flow and adjusting payroll to bring all of the moving parts of the operation into harmony. Be transparent about when and how employees are compensated. Before making any payroll cycle changes, check with the labor department to ensure your company remains in compliance with prevailing laws and regulations.
7: Obtain a Business Line of Credit
Savvy use of cash flow management tools helps company leaders take proactive measures. Because of its predictive nature, cash flow assessments provide advanced warning that financial shortfalls are on the horizon. This gives industry leaders an opportunity to secure funding before things become financially tight.
The popular short-term borrowing resource involves establishing a business line of credit. Small and mid-sized organizations often establish a business line of credit as soon as they acquire a federal tax identification number. These loan products often serve as a backup resource when revenues fall near or below operating expenses.
Leveraging a business line of credit can prevent closures, laying off valued staff members, and other issues. Business lines of credit allow companies to draw down funds on a need basis and only pay back what they use.
Cash Management Solutions Can Help
If your business would benefit from cash management solutions, Middlesex Federal can help. For more information on solutions to help simplify your finances, please contact us or stop by one of our convenient branch locations today.