Regardless of the scale of your business, how well you manage your cashflow will decide whether it ultimately succeeds or fail. Cash flow could be regarded as the blood that flows within the veins of your business.
According to a study carried out by Jessie Hagen of US Bank, cashflow is the primary reason why a business fails due to financial reasons. In fact, he estimated that a whopping 82% of the time, businesses crumble due to poor cashflow management.
The importance of knowing how to manage cashflow can’t be overemphasized, but before that, you have to understand what cashflow is and why it’s so important.
Cashflow can be defined as the amount of money that comes in and out of your business in a specified period of time. Your cashflow can either be positive (in the green) or negative (in the red). We’ll drop the heavy grammar and explain it in simple terms.
You have a positive cashflow when there is more money coming into your business than you have leaving it i.e. the money being earned is greater than the money being spent. While you have a negative cashflow when your business spends more than it makes within a specified period. A negative cash flow indicates there is an imbalance in the revenue stream. Bear in mind that it doesn’t necessarily equate to loss.
Cashflow and revenue should in no way be confused with one another as there is a clear difference between the two. Revenue is the amount of money that a company or business earns from the sale of products and services, while cashflow is the net amount of cash that comes into and leaves a company or business. Where revenue measures the effectiveness of a company’s sales and marketing, cashflow indicates the liquidity of a company.
Now that we have established a firm understanding of cashflow, we will see the various ways in which you can manage your cashflow.
You cannot manage your cashflow effectively without knowing how to calculate it. There are two generally accepted methods of calculating cashflow statements. They are:
This is a cash-based operation; what that means is that this method for calculating cashflow involves subtracting from cash sales only those operating expenses that consumed cash. For this to be successful, you need to record every cash transaction, and then deduct cashflow from the inflow. That includes items such as cash receipts, interest received, and income tax payments
In this method, a technique known as accrual accounting is employed. Accrual accounting represents the liabilities and non-cash-based assets recorded over a period of time. In short, accrual accounting is defined as the entry of transactions into accounting books as they occur even without receiving payment for those goods or services.
Small scale businesses prefer this method to record cash received and cash payments as they can record transactions whenever they happen without having to wait for when they receive the cash payment.
You will have to use income statements to eliminate transactions that do not reflect cash transfers.
It is next to impossible to run a smooth business operation without having a firm grip on what bookkeeping is.
Bookkeeping is the process of keeping tabs on all of your business’s financial transactions i.e. what goes in and what goes out. It lets you see exactly where your business is spending money, where your income is coming from, and also tax deductions.
This is the single most important step in managing cashflow.
2. Cashflow Statement
Cashflow Statement is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents. Generating cashflow statements can easily be done when you have an accountant. If you don’t, you can use a software or spreadsheet to generate your cashflow Statement.
Go to QuickBooks for easy cashflow statement generation and forecast
3. Analyze Your Cashflow Statement
The next step in managing your cashflow is by analyzing the cashflow statement generated by your account, spreadsheet, or software. This analysis is important because it helps you understand how money moves through your business.
A good scenario is when your revenue streams are not as effective as they should be i.e. they aren’t producing as much money as projected. Cashflow analysis will help to highlight the problem. When a business is not producing money as much as it should and it maintains the amount of money it spends, eventually it’ll end up in the red zone, a negative cashflow.
4. Credit Management
Credit management is another good measure for managing cashflow problems. When you give out credit to your clients, your cash in-flow drops because you record the credit that you give out as accounts receivable rather than as cash payments. When you sell products on credit, you normally give your clients a certain window to pay for those products. But in the meantime, your cash flow drops because you paid for the inventory with cash that is yet to receive a payment from the client(s).
5. Reduce Spending Where Necessary
When you overspend because of unnecessary expenses, it affects your positive cashflow in the sense that it reduces it. So cutting down on spending cash unnecessarily increases cash flow.
6. Shorten Accounts Receivable Window
Account receivable or AR is any amount of money owed by customers for purchases made on credit. ARs are always marked as current assets on the balance sheets.
When you, as a business owner or company, sell products on credit, depending on how long payment is due, it could affect cashflow. When the window is too wide, it will affect your cashflow negatively.
Shortening the accounts receivable window ensures you always have more cash flow as credits are paid quicker.
7. Provide Discounts on Products
One might raise an eyebrow at this, but really, it is a good way of ensuring quicker payments on products.
For instance, if your payment terms allow a 30-day window for payment after the receipt of an invoice, with at least a 2% discount if paid within the first 14 days, this will encourage quick credit settlements.
Bear in mind that you can offer more, less, or no discount for payment, depending upon your needs and your customers’ payment habits.
There’s a saying that “revenue is vanity, profit is sanity, cash is reality”. It is no overstatement that cashflow is indeed the lifeblood of any business. Managing cashflow is all about ascertaining when you’re going to have cash in hand, how to get more of it in your hands faster, and how to spend it wisely so as not to create cashflow problems.
Knowing how to manage your cashflow is a fundamental skill for effectively managing your business finances. Once you’re able to do this properly, the thing for you will be to grow your business to realize even greater profits.
You could also read on: Why 90% of Startups Fail and What to Do About It