Amy Hardison White

Understanding Your Business's Cash Flow

Many of us have an idea of what cash flow is relative to our personal finances. If you have a full-time job with a regular salary, there’s a fixed amount of cash coming into your household on a bi-weekly or monthly basis. Before you receive the cash, you probably have things like taxes, social security, and health insurance fees taken out.

Each month, you’re likely to be spending that cash on rent or a mortgage, utilities, car payments, groceries, and other incidentals. Hopefully you’re putting some of it away in savings as well! And you might also be planning for a big vacation annually - an important item that will take a big hit, but not on a monthly basis.

Businesses operate in a very similar fashion, but most of them don’t have the luxury of a fixed income. They still have a set of fixed expenses - like rent, utilities, phone lines, and employee salaries, for example. However, businesses are constantly acquiring new customers and losing old customers, so they don’t have a guaranteed income.

Customer payment terms may make it such that businesses don’t receive cash until 30, 60, or even 90 days after the purchase date. And businesses sometimes must incur additional expenses beyond their current cash reserves - maybe to expand into new locations or markets, or hire new employees.

What options do individuals and businesses have if they don’t have enough cash coming to meet their financial needs? Both can go out and secure credit in different forms. Individuals are more likely to apply for a credit card, and businesses may apply for a line of credit, a loan or look for investors to provide funding.

If you have a credit card, you know it is critical to pay off the balance in full each month to avoid heavy interest charges. Businesses must pay off their credit as well, but the terms may be longer depending on the type of credit they’ve acquired.

Even though businesses may have access to credit with longer terms, they must have positive cash flow to stay in business for the long term. If you went out and racked up a large amount of credit card debt that you couldn’t pay, you’d probably end up bankrupt. The same goes for businesses. And even without the credit, if a business can’t keep consistent cash coming in the door, it can’t keep operating.

So what exactly is cash flow? According to Investopedia, a financial education website, cash flow is “the net amount of cash and cash-equivalents moving into and out of a business.” And to get more specific, Entrepreneur’s small business encyclopedia defines cash flow as “the difference between the available cash at the beginning of an accounting period and that at the end of the period. Cash comes in from sales, loan proceeds, investments and the sale of assets and goes out to pay for operating and direct expenses, principal debt service, and the purchase of asset.”

In the simplest terms, a business’s cash flow is equivalent to an individual balancing his or her checkbook in a formatted manner. It is the recording of cash coming in for services or products, and cash going out to pay for debts and expenses. Cash flow statements, which record a business’s cash flow, are different from income statements, in that income statements include cash payments due to a business that have not yet been received.

The best way to be informed about your business’s cash flow is to create and regularly review cash flow statements. First, determine the most effective time period for your cash flow statements. You can start with monthly statements and easily roll them up to quarterly and annual statements, depending on how frequently you plan to review them.

A business’s cash flow is broken down into three categories:

  • Operating cash flow is cash coming in and out of a business relative to its’ day-to-day operations. Examples are cash coming in from product and service sales, and cash going out for employee salaries and office rent.

  • Investing cash flow is the increase or decrease in cash that come from a business’s investments in the stock market or funds used to purchase capital assets for the business. Capital assets can be equipment or real estate.

  • Financing cash flow reflects cash moving through the business to raise funds or pay back investors, such as paying stock dividends to company shareholders or selling stock to new shareholders.

If you run a small business with no investors, your cash flow might fall solely into the operating cash flow bucket. Or you might have some capital assets to include. Whatever the case, you’ll need a list of all incoming and outgoing cash to create your cash flow statement for any given time period. A quick Google search will yield various cash flow statement templates - choose the one that best meets your needs.

Once you start creating and review cash flow statements, it may become clear that you could do more to be cashflow positive. You might be lacking funds to pay employees regularly, or missing out on potential expansion opportunities because investors view your business as too risky. Here are a handful of tactics that may help boost your business’s cash flow:

  • Optimize accounts receivable to make sure customers pay invoices quickly. Take a look at payment terms for your customers. You could shorten the time to cash by asking for payment in 30 rather than 60 days, for example.
    You could also offer discounts to customers that pay more quickly, or use invoice financing or invoice financing if you need cash urgently. Be flexible in specific situations - if long-time customers balk at the idea of faster payment terms, implement the new terms for any future customers. And take a look at any issue resolution your receivables team deals with, such as incorrect invoices. Errors could be delaying customer payments, so make sure invoices are sent out correctly.

  • Look to accounts payable to reduce or delay payments to vendors.Evaluate the vendors your business uses, and approach the most frequently used vendors to see if they will offer discounts or allow you to delay payments. This approach is especially effective if you get a get together with other customers and ask the vendor for a group discount. Consider applying for and using a business credit card to make vendor payments, which will allow you to delay payment to the cycle date of the credit card.

  • Closely monitor inventory to ensure you are only carrying products customers will buy. Are you holding on to a lot of inventory that isn’t moving? If so, consider selling it at a discount to keep from incurring additional costs. Regularly analyze your inventory so you only keep on hand products that are moving quickly. Segment your analysis based on product so you aren’t carrying extra inventory costs.

  • Consider leasing equipment instead of buying to avoid big outlays of cash. This one goes contrary to our perceptions of home ownership regarding the value of buying a home. Before buying any new equipment, take a look at the cost and how it might impact your cash flow. It may benefit your business to have a lower short-term equipment cost so your business has more cash on hand. You can always purchase the equipment later when you’ve established positive cash flow.

Cash flow is a concept at the heart of every home and business. Managing and understanding it may seem like a complex task, but it’s really all about different ways of displaying the cash going in and out. Cash flow is a critical metric for the success of any company. With a small investment of time and effort, you can regularly review your business’s cash flow and take steps to improve it.