One of the most important pieces of any company’s financial health is cash flow. Cash flow refers to the amount of money coming into your business (also known as inflow) as well as the money going out of your business (outflow) at a given time.
Here’s what you need to know about tracking and maintaining your business’s cash flow and why it’s so important to do so.
Why does cash flow matter?
Having a positive cash flow ensures a company has enough cash balance on hand to meet all of its expected (and unexpected) financial obligations. A cash flow surplus can be set aside as a reserve for leaner times; it can also be reinvested into the business for long-term growth.
The most common source of inflow is customers’ cash payments for goods and services; borrowed funds and gains on investments can also drive cash inflow. Outflow is driven primarily by operational expenditures, such as payroll and rent; other outflow sources include debt payments and the purchase of fixed assets.
Types of cash flow include operating activities, investment activities, and financing activities. Ideally, a business should have a net positive cash flow.
Are cash flow and profit the same thing?
Despite their apparent similarities, cash flow and profit are not the same. Cash flow is simply the inflow and outflow of funds from a business. Conversely, profit specifically refers to how much money a business is making overall, calculated by subtracting expenses from revenues.
A business can be profitable but still have a negative cash flow; it can also have a positive cash flow but struggle to make a profit.
Having a positive cash flow ensures a company has enough cash balance on hand to meet all of its expected (and unexpected) financial obligations.
What factors impact cash flow?
The following factors can impact your overall cash flow:
- Accounts receivable: This number refers to the balance of any sales that are yet to be collected in cash — in other words, what your customers owe for goods or services received. Your credit terms and credit policy can affect the timing of customers’ payments; a policy that is too strict might make it difficult for customers to pay, while a policy that is too lenient could leave your business without necessary cash for an extended period of time.
- Inventory: Particularly for companies that sell products, inventory management can have a significant impact on your cash flow. If you purchase more product than necessary to meet market demand, you may find yourself with an inventory surplus that cannot be sold — effectively, wasted outflow that could have been better spent elsewhere.
- Unexpected expenses or loss of revenue: Even if a business has enough cash flow to cover the day-to-day, it may not always be financially prepared for the unexpected. Significant one-time expenses, such as replacing technology and equipment or recovering from a natural disaster, can put entrepreneurs in a cash flow crunch. Additionally, sudden national or global market changes can also affect customers’ spending habits (or ability to make payments).
[Read more: The Pros and Cons of Extending Credit to a Customer]
How can I maintain a healthy cash flow for my business?
Companies can increase positive cash flow in three primary domains: revenue (how much money you’re bringing in), operating margin (how much it costs to run your business), and capital efficiency (how efficiently you are spending your money). Here are some strategies to help you maintain a healthy cash flow for your business:
- Price your products according to demand: Assess your pricing in comparison to similar products or services. Are your offerings in high demand? Is there limited competition in your domain? If so, you can adjust your pricing upward to increase cash flow from each sale.
- Evaluate your products and inventory: Redesigning products to use common parts can make it easier (and cheaper) to produce your offerings. Some suppliers also offer volume purchase discounts, so prioritizing those suppliers can improve cash flow.
- Establish favorable payment terms: This may include negotiating with suppliers to create longer payment terms, as well as tightening your business’s credit policy to ensure you aren’t “out” a significant amount of cash for an extended period of time.
- Keep track of your business finances: A well-organized cash flow statement allows you to assess inflow and outflow (as well as profit and loss), as well as make adjustments to your expenditures as needed to stay within budget and improve your cash flow.
[Read more: 7 Small Business Financing Trends to Watch in 2023]
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