Small businesses tend to ignore cash flow in favor of sales. Resist that temptation, and your odds of success go up dramatically.
It’s all too easy to think that selling more products and services month over month and year over year is the key to your company’s success. But in truth the actual amount of cash flowing in and out of your business is what actually determines its health and viability. Unfortunately, that simple fact is often overlooked by small-business owners.
“Small businesses tend to be weak on cash flow forecasting,” says Dewey Martin, CPA, CMA, and director of the School of Accounting at Husson University in Bangor, Maine. “There’s an intense focus on sales and getting work done or products sold, but less so on promoting healthy cash flow.”
What’s often overlooked, he adds, is that “as businesses grow, both the balances of inventories on hand and the accounts receivable outstanding increase. Therefore the business looks profitable due to those measures of growth, but in the short term the owners are desperate for cash because their profits are tied up in inventory and receivables.” Many a business, in fact, has been forced to close due to its inability to meet its near-term obligations, even though its longer-term prospects look good.
Your company can take a number of steps to get a better handle on cash flow. These include constructing a cash flow budget, making invoicing and collections a priority, and arranging for a business line of credit to support your financing needs during cash flow droughts.
The budget you may not know about
Business owners need to look at not only how cash comes into a business in the form of revenue, but also the ways that cash goes out of the business in terms of expenses. That is where the rubber really meets the road in terms of how fast a business grows and whether it will survive.
The most useful tool is a cash flow budget. You can create this essential financial snapshot either by sitting down and looking at how your cash cycles in and out of your business (it works best if you can do this analysis for a period covering several years), or ask your accountant to help you create one in the form of a spreadsheet that you can then easily maintain going forward. That will help you understand how you receive money and how you spend it, which will help you become more intentional about your growth.
To keep your cash flow on an even keel, ensure that your invoicing and collections processes are a top priority, and maintain a bank line of credit to draw on when accounts receivables are high.
Once you have a clear picture of your cash flow you can make better decisions on a host of issues that are crucial to your company’s growth. Without knowledge of how cash flows in and out of a business, both in terms of revenue and expenses, it’s impossible to know what you can really afford, or to make the best choice when contemplating an array of potential expenditures.
“Many business owners are amazed at what they learn when they pay attention to how cash actually flows through their businesses,” says Martin. “Ongoing, regular expenses such as payroll tend not to be a problem, but what can become a major problem is capital expenditures and other large one-time expenses. When you plan those expenses with a better awareness of your cash flow, you can be more intentional about how you employ cash to grow your business.”
It’s much easier to budget for expenses that will foster long-term growth, such as new equipment and new hires, when you understand how the cash is coming into and out of your business. Be sure your analysis takes into account seasonal ebbs and flows, because cash flow is not always consistent, and for some companies the peaks and valleys can be extreme. Increasing sales quarter over quarter and year over year is important, but while you keep one eye on sales growth to power your company’s long-term success, keep the other on cash flow, to be sure you’re fine in the short term as well.
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