Improve your business by understanding cash flow

Improving the cash flow for any business can only help it flourish. That is the case for all business owners! Even one that has a great business model, is profitable and has investors lining up to buy into your company. If you are looking for one thing to focus on that will have a dramatic impact on your business, cash flow is it!

New and growing businesses can sometimes not have a buffer of extra cash to get them through shortfalls. Because they are constantly reinvesting it does leave them a little vulnerable.

Cash flow management is one of many reasons it’s so hard to get a new business off the ground. It is the case that 80% of failed business put that down to poor cash flow.

Cash flow is on the minds of all small business owners, particularly in today’s economic climate. Here are a number of ways you help improve the cash flow relief for your business.

Short-term revenue strategies include:

Discounts and coupons can help drive sales today, though we recommend caution. Don’t get too far ahead of yourself and unable to deliver the goods when your crisis is over

Gift Certificates are an excellent way to generate immediate sales, if you are an industry where that is appropriate

Explore small business support, financing, and grants such as Government relief programs for small businesses.

What is cash flow management?

So, what is cash flow management exactly? Cash flow is the amount of money, cash and non-cash, travelling into and out of a business. at any given time. A positive cash flow is more money coming in than going out, and a negative cash flow is less money coming in than the business needs to cover outgoings.

To calculate cash flow, a business you should note down the cash available at the beginning and at the end of a specific period. You might look at a week, a month or even a quarter. The period chosen will be determined by your billing cycle perhaps. To work out how stable your cash flow is there will more in the account at the end of the period than when the period began. If the opposite is true, you need to examine this closer!

Getting good at cash flow management is one of the best things you can do for your business. Not only that, it’s a skill you can carry over to your personal finances.

The difference between cash flow and profitability

Cash flow is different from profitability. Don’t be fooled into thinking that a profitable business is able to pay its bills. If the cash flow is poor, it actually may not be able to.

Profit is a basic small business accounting term, which exists on paper. Measuring profit is a particular way of looking at a business. It doesn’t tell you how the business is getting by day-to-day and how the cash flow is looking.

How to calculate profit:

The best place to start in calculating profit is to take your total revenue and then subtract the cost of goods sold. The difference is your gross profit.

Revenue – Cost of Goods Sold = Gross Profit

So if you sold $100,000 in meals in your restaurant and the food cost you $50,000 wholesale, your gross profit would be $50,000.

Revenue: $100,000 Cost of Goods Sold -$50,000 Gross Profit: $50,000

There are other expenses beyond buying the food though that needs to be factored in too. Staff, premises and advertising all need to be accounted for. These expenses are the operating expenses, and they get subtracted from your gross profit.

The second step is to subtract operating expenses from gross profit. The difference is net profit.

Gross Profit – Operating Expenses = Net Profit

Revenue: $100,000 Cost of Goods Sold: -$50,000 Gross Profit: $50,000 Operating Expenses: -$35,000 Net Profit: $15,000

If your net profit is a positive number, you made money. If it’s a negative number, you lost money. This report as a whole is called the income statement, or profit and loss (P&L).

The “problem” with profit

In relation to small business cash flow management, the problem with income statements is that they don’t show the whole business. A few essential pieces of information are missing.

1. Debt repayment.  If you have any business loans or other credit to repay, it won’t show here. Only the interest on those loans is included on a P&L, even though the total repayment can eat up a lot of your revenue.

2. Taxes – Note that your net profit isn’t taxed at this point, which means it will shrink even more.

3. Cash received. Finally, many businesses use accrual accounting, which records revenue even if you haven’t received the money yet. On paper, you might have $200,000 in sales, but if no one has paid you yet, you’re still going to have a hard time paying your bills. This is your cash flow and this is not a great position to be in.

How do you manage cash flow and profit?

Managing cash flow comes down to timing. You may be profitable over the course of a month or a year, but not on a specific day or week. If your bills are due at the beginning of the month but you won’t have any money in the bank until the end of the month, you’ve got a cash flow problem.

But just because you’re profitable doesn’t mean your business can run on autopilot. You still need to practice cash flow control—especially if you’re growing.

Why is cash flow management important?

Although it may seem intimidating, there are clear benefits to cash flow control. The prioritization of effective cash flow management should be paramount in every business.

1. Learn to Predict shortfalls. The first and most obvious benefit to managing cash flow and working capital is knowing ahead of time where your shortfalls will occur. Don’t find out you can’t make rent after the payment bounces back into your account. With a good accounting system in place, you can predict shortfalls weeks. You can even predict problems months ahead of time. That gives you time to come up with a plan. 

2. Reduce stress. Managing your cash flow will help you ease some of your stress. The anxiety entrepreneurs experience around paying bills comes from not knowing what’s going on. They and worry about whether or not the payments will be made. It’s much better to know what’s coming, even if the outlook is not good. When you know where you stand, you’ll feel prepared. More importantly, you’ll be equipped to deal with it.

3. Know when to grow. When you’re managing cash flow, you know exactly how much money you have to spend on growth and reinvestment. Remember, just because your P&L tells you there’s extra money lying around, doesn’t mean it is actually there.

Just because you have $20,000 in the bank doesn’t mean you can spend it. You might need it to pay for upcoming expenses. When you look at your cash flow over weeks and months, you’ll know how much to keep on hand and how much you can stash away or spend on growth.

4. Gaining leverage. Good cash flow management gives you leverage when looking for credit. Banks generally like to see cash flow planning, especially if you can clearly show when you’ll be able to repay the funds. Suppliers tend to be flexible if you can tell them exactly how you’ll pay and when. These people want your business and will be more willing to work with you through the ups and downs if they can trust you.

5. More accurate. Cash flow is more accurate than a budget. Budgets tell you what you want to happen, wishful thinking, and entrepreneurs are optimistic by nature. Cash flow projections tell you what is actually happening so you can deal with it.

How to manage cash flow

One of the most effective ways to manage your cash flow is to get an expert involved. Using a really good quality Accounting Software programme will help. We recommend Xero to all of our clients. There are many reasons why and you can read about some of these here.

You have options, get it set up by a pro and then one-to-one training on how to manage the books on a day to day basis. The other option is to hand the books over entirely to a contractor, a bookkeeper who can manage all of your bookkeeping needs for you.

The team at Keeping Numbers have been working with clients for many years and have a range of specialists within the group. If you would like to chat through your options, reach out to Liz Peacock who can help you come to the right decision for you and your business.

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