The most challenging problem for any business is keeping track of its cash flow. This is especially true when a company is new because owners are so focused on operations that they rarely pay attention to numbers. The problem is exacerbated when the business owner lacks financial expertise.
However, if you don’t keep track of your cash flow, your business could fail before it gets started.
Every business owner must master proper cash flow management for long-term financial success.
According to a recent Intuit study, 61 percent of small businesses worldwide struggle with cash flow. Due to cash flow issues, nearly one-third of those polled cannot pay vendors, loans, themselves, or their employees.
You can incorporate several tactics into your business model to combat this struggle and stabilize your cash flow.
Why is cash flow management important?
Cash flow management is critical to the success of your business. You will steer your company in the right direction if you can accurately forecast cash flow.
You can get ahead of the market if you understand cash flow techniques. Because you understand the revenue cycles of customers, vendors, suppliers, and contractors, you’ll even be able to predict cash flow.
Every business has high and low seasons; understanding upcoming expenses for employee overtime, replacement equipment, and other requirements goes a long way toward ensuring your company is well-positioned to handle any bump in the road.
The first step is to determine how much cash flow your company requires.
How to calculate cash flow
Understanding how to calculate cash flow is one of the most important aspects of managing it.
There are three main formulas for calculating cash flow: the free cash flow formula, the operating cash flow formula, and the cash flow forecast. Each formula serves a distinct function.
- The free cash flow formula refers to the resources available for distribution among all stakeholders in the company. It indicates how much capital you have available to reinvest in your business, such as purchasing new equipment, expanding your store, or investing in a new product for your company.
- The operating cash flow formula provides a quick snapshot of your company’s day-to-day cash flow.
- The cash flow forecast anticipates your cash flow for the next month, quarter, or year.
All three of these formulas are critical for understanding how much money is flowing in and out of your company at any given time:
- Free cash flow = Net income + Depreciation ÷ Amortization – Change in working capital – Capital expenditure
- Operating cash flow = Depreciation + Operating income – Taxes + Change in working capital
- Cash flow forecast = Beginning cash + Projected inflows – Projected outflows
How does a business get positive cash flow?
Sales is the easiest way for a business to increase its cash flow. You aren’t truly a business if you aren’t making sales. Of course, reducing operational costs also helps. Having comprehensive budgets and cutting back on wasteful expenditures is crucial.
What actions should you take if your cash flow is negative?
These are some choices you have if you have a cash flow deficit:
- Make a loan request to a bank or a person.
- Apply for a bank line of credit.
- Increase the collecting rate.
- Equipment purchases can be financed via loans or leases.
- Asset liquidations.
- Delay making vendor payments.
There may be occasions when you have extra money. You don’t want that money to just sit there because it can influence your future opportunities. Accountants advise you to put your surplus to work. This can be accomplished by making short-term investments and using the proceeds to settle debts more quickly. In this manner, you will gain from the money through interest generation or shorter loan terms.
Always seek the advice of a qualified accountant before making significant financial decisions that may have an influence on your company’s future.
Top 5 Cash Flow Management Skills You Need
Although it is not magic, you do not need a degree in finance to understand and manage cash flow. A few mathematical abilities and close attention to incoming and outgoing communications are essential.
Your cash flow statement is like a budget. It lets you view what will be coming in or going over a predetermined timeframe. You should look at least six to eight weeks into the future. Forecasting for three to six months is more prudent if you know you will incur significant expenses.
You can determine whether enough money is coming in to cover what needs to be paid using your cash flow statement. Regular estimates take into account both ongoing expenses and long-term investments. Business owners might feel very confident when they know they have enough money in the bank to cover expenses for several months.
2. Managing the Debt Ratio
Debt has a cost, and business owners need to be aware of this cost before taking on debt. Maintaining a favorable debt-to-income ratio entails having a sizable income compared to modest payback commitments. It is simple for the company to pay its financial responsibilities when the debt ratio is low.
A debt burden is at the other extreme of the range. Businesses find it difficult to pay back loans and other obligations, which puts them in this scenario. An excellent method to manage your company’s debt ratio and prevent a debt load is to keep debt to a low and make sure that payments are completed on time.
3. Maintaining a Reserve
When times are difficult, having an “untouchable” cash reserve for emergencies might save a corporation. When the epidemic first broke out, countless UK firms learned how crucial quick access to capital was, compelling them to make immediate, extreme changes and even temporarily close.
There is no requirement that a cash reserve is an actual cash. Instead, companies can use a line of credit that has already been approved and can be swiftly accessed in an emergency. Having said that, be careful with the amount of debt you take on. To prevent permanently affecting your debt ratio, your company should only temporarily draw from its emergency cash reserves and repay them as soon as possible.
4. Monitoring the accounts payable
Oversights are frequently the only reason for late payments. Your company can receive payment up to two weeks earlier by using software and automating the reminder and chasing processes. This helps bridge the financial gap between the initial outlay for your company’s goods or services and the money you get paid. Simply, it maintains a healthy cash flow.
Automation entails more than just reminding people to do things. Incoming payments are automatically reconciled through the software’s integration with the existing accounting platforms used by your company. As a result, you have more time to focus on growing the company.
5. Current Payables Maintenance
Long-term reputation damage from being known as a “poor payer” will affect your business. Building a strong reputation requires time, but losing it quickly does not. Years may pass before that good reputation is restored.
Additionally, your supplier can suffer as a result of your late payment. Paying on time will significantly impact the firm’s financial stability, especially if you are purchasing goods and services from sole proprietors or small businesses.
You can protect the future of your own company and help others by keeping your accounts payable current and paying invoices on time
Keeping your business alive is connected with managing financial flow. Your company’s future can be secured by ensuring it generates enough revenue to comfortably meet all projected expenses.
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