Starting a new business is an exciting yet stressful time. With so much to do and learn, it can be easy to feel lost or overwhelmed. You can have a great business idea, make a profit, and still get into trouble by mismanaging cash flow. Cash remains king in the business world, and every company requires funds on hand to cover their outgoings.
So, let’s dive into the ins and outs of cash flow management to ensure you have a good night’s sleep for years to come.
What is cash flow?
First, we need to clearly define what we’re talking about. Cash flow refers to the money flowing into and out of your company.
Cash inflow (sources of funds) could include revenue from sales, borrowed money, investment capital, or any grant money you have received. Cash outflow (uses of funds) covers every business bill payment and operational expense you have, from payroll, supplies, and materials to rent, utilities, asset purchases, interest payments, and more.
Your net cash flow (subtracting the outgoings from the incomings) determines if you have a surplus or a cash deficit at a given time.
With a positive cash flow (incomings are greater than outgoings), you have cash on hand to put towards other means. Maybe you save it for a rainy day. Perhaps you invest, purchase new resources, or hire new staff to expand your operations. A negative cash flow (outgoings greater than incomings) means you’re unable to cover all your expenses, and you’re in danger of going into the red.
The difference between cash flow and profit
All this might sound similar to profit, but there’s an important distinction between the two.
Profit refers to the revenue left over after all of your bills and operating expenses are paid. It’s based on the accrual accounting method, meaning transactions aren’t recorded simultaneously with the transfer of cash.
Cash flow is a real-time reflection of your business’s bank account. It uses the cash accounting basis to show the reality of when money is actually coming in and out of the company.
For example, you purchase goods and record that as an expense for your business. However, you use a credit card, so the funds don’t leave your business until you pay the bill at the end of the month. To calculate profit, you mark the expense on your books at the time of the purchase. In terms of cash flow, you wait until the credit card bill is paid.
Cash flow considers the inherent delays in transactions, showing how much money is coming in and out of the business and precisely when the money was transferred.
Why cash flow is so important
As a business owner, it can be easy to focus on profit at the expense of the real-life funds available to you at a given moment. This can be problematic as it’s possible to run a profitable business and still end up strapped for cash by mismanaging incoming and outgoing funds. Furthermore, your bills could all occur at the same time of the month or at a poor time for your revenue streams.
Whatever your business circumstances, understanding the connection between cash flow and profit is critical to ensuring all of your responsibilities are met without going into debt and incurring additional fees or interest.
Prioritizing cash flow is critical to successful business planning. Knowing when money will be deposited and withdrawn from your account, you can manage your finances properly. For example, you can organize the timing of bills after your most significant cash deposits or select an appropriate bill payment method to retain cash for longer without triggering late fees.
Projecting cash flow
Effectively managing and accurately projecting your cash flow puts you in the best position to make the most of your funds. This includes understanding your revenue streams, your bills, and how vendors want to be paid.
Unfortunately, cash flows change from month to month, making it hard to plan for the future. All businesses have low and high revenue months, and each business has to understand the dynamic nature of its upcoming bills. Perhaps you need to spend more replacing equipment or pay additional overtime this month.
Cash flow projections—understanding when money is coming in and when it needs to be spent—is a fundamental part of the budgeting process. As a new business, you don’t have historical data to inform future projections. Instead, you’ll need to closely monitor revenue streams and determine how they are progressing.
Take into account potential operational changes (hires, new pricing, etc.) and diligently track your outgoings. Cash flow projections should constantly be updated to reflect any new information. This includes comparing your projections to real-life deposits and bills to determine whether you are regularly over or under-estimating certain deposits or bills.
A simple projection strategy is to take the cash you already have and add all the money you expect to be paid. Then subtract all your upcoming payments based on your best estimates.
Cash flow management tips
There are a number of ways to improve cash flow management. These typically involve delaying accounts payable (paying your bills) as much as possible without triggering late fees and speeding up accounts receivable (revenue coming into your business).
Some simple cash flow management tips to get you started include:
- Promptly sending accurate invoices to all clients.
- Borrowing funds or opening lines of credit before you need them.
- Building strong vendor relationships and structuring payments around your incoming deposits.
- Leasing equipment to avoid paying large lump sums up front.
Managing your cash flow for long-term success
Cash flow is a strong indicator of your company’s health. To survive and grow, you need an effective cash flow strategy that considers the specifics of your business model. By taking the time to project future cash flow and plan for upcoming bill payments, you give yourself the best chance of turning your business into a long-term success.