“Cash is king” is an adage used to describe business. It means that cash flow is the blood that keeps the heart of a kingdom pumping, thus illustrating the significance of cash flow to a business—especially a small one.
The Definition of Cash Flow
Cash flow is the management of bills coming in and out of a business. It is critical for a small-business owner to understand the importance of cash flow, because it is one of the most important components to the success of a small business. Without cash, profits are meaningless.
The Difference Between Cash Flow and Profitability
Cash flow is the movement of money in and out of your business through cash, checks, electronic debits, and credits.
Profitability is the ability of your business to generate more sales and dollars than the cost of your business expenses.
It is essential to understand that cash flow and profitability are two different concepts. Profit does not necessarily equal cash.
Nevertheless, it is important to understand that despite the difference between cash flow and profitability, the two go hand-in-hand.
Cash flow is calculated when a payment has been received. Profit is calculated the moment a sale is made, even if the payment hasn’t yet been received. If customers are not paying their bills on time, your company will not have money to pay its bills on time.
Therefore, profitability is only possible if a company strengthens its cash flow.
Positive Cash Flow Versus Negative Cash Flow
Positive cash flow is when the amount of cash coming into your business is more than the amount of cash leaving your business.
Negative cash flow is when the amount of cash going out is more than the amount of cash coming in.
How to Improve the Cash Flow of Your Small Business
Learn to predict tomorrow’s cash flow. To predict how much money your business will have in the future, try to predict its potential sales. Also, figure out the rate at which you will collect money that is due to your business, along with the amount of money that needs to be paid to your vendors. If you consistently analyze your company’s cash flow, you will lower the chances of suffering from cash flow crunch, which is the shortage of cash in a business.
Cash flow predictions for long periods of time are more useful, but they can be less accurate. To make more accurate projections, estimate cash flow for up to six months—then update your projections once a month.
- Focus on existing customers. Analyze how much of your product customers are buying and why they are buying it. This is a cost-effective way to increase profit and generate sales.
- Set up a sales incentive program. Give your salespeople incentives to get out there and sell! Recognize and celebrate salespeople for their achievements. Recognition gives people a sense of accomplishment that motivates them to keep up the good work. This is a great and cost-effective way to inspire a salesperson to make a sale!
- Fill your customers in. Let customers know about upcoming sales when they’re in your store, or by phone or email. They will be sure to come back, and they may bring some friends along!
- Reward your customers. Provide customers with birthday discounts or point systems that allow discounts once they’ve spent a certain amount of money. These tactics will both increase sales and build customer loyalty.
Watch out! Have good money management in your small business. If your money is not managed properly, you may not be able to make investments that are necessary to compete with other small businesses. Bad money management may also lead to your business having to borrow money.
Various factors affect the cash flow of your business, including accounts receivable, inventory, accounts payable, capital expenditures, and debt service. Focus on these factors to maintain positive cash flow in your business:
- Create capital expenditures so you do not spend too much money on purchasing inventory and equipment. Capital expenditures, or CAPEX, are funds used to acquire or upgrade assets.
If an expense qualifies as a CAPEX, your business could extend the cost of the expenditure over the amount of time the asset is functional. If an asset’s cost can be maintained in its existing state, the cost will be subtracted in the year of the expenditure.
- Make sure you are not slow in collecting accounts receivable. To make collecting receivables easier, get a lockbox service. Your bank can provide your business with a post office box. When customers send checks to the post office box, the bank will be able to process the money faster. It is also a good idea to keep your banking at one bank, and offer your customers discounts for paying their bills quickly.
- Create an accounts payable department. The AP department will make payments to vendors and providers in a specific amount of time. This will avoid default, which can happen if a business does not pay its bills on time. It may also be smart to look into receiving help from a debt service, which will help your company use cash to repay interest on a debt.
- Beware of bankruptcy! Small-business owners run the risk of losing track of the amount of money coming in and going out. Check your cash flow statement regularly. If you notice that cash flow has been negative for an extended amount of time, you may want to check your money in the bank. It may be getting low. Keeping tabs on cash flow statements will help maintain the positive cash flow of a small business.