The foundation of a successful small business rests on knowing how to manage a healthy cash flow for said business. Some small business owners get into trouble by confusing their personal finances with the separate business cash flow. While the two may be intertwined to some extent, every business owner should understand and accept the fact that personal finance and business cash flow are two separate entities that need to be carefully and completely defined and separated. To do otherwise is to court financial embarrassment, if not disaster.
At its most basic level, a cash flow action is concerned with either a virtual or a real movement of money. They normally occur between one bank account and another bank account — or one credit union account to another credit union account; the important point being that the transaction takes place within the infrastructure of a recognized and licensed financial institution. Most cash flow activity is calculated and based on future activity — not present action. A cash flow transaction may be scheduled to take place tomorrow or a month from now. Cash flow activity is calculated using a formula incorporating the time it takes place, the nominal amount being transacted, the name on the account and the type of currency being used. It is written by economists thusly: CF=CF(t,N,CCY,A). But for plain business purposes, a cash flow can be considered as any transaction that involves payments out of or into a business account or a recognized financial instrument or monetary project.
All cash flows are correlated with the concepts of liquidity, interest rates, and a recognized standard of value. Statistics show that when these basic cash flow rules and concepts are misunderstood or misapplied nearly 85 percent of new small business fail to meet their initial expenses.
Each small business owner owes it to himself or herself to be able to take charge of their own cash flow activities — either attending to it personally or delegating it to someone they implicitly trust and can monitor closely at all times.
Some of the key concepts of cash flow that a small business person must be familiar with include:
The rate of return; internal rate of return; and net present value. This is the speed or rate of cash flow into and out of specific business projects.
Liquidity. This is important mainly because it determines how flexible a business can be with expansion and in meeting other unexpected contingencies.
Operational cash, or cash on hand. Without a firm knowledge of this amount, a business owner is only guessing, or just gambling, with company assets whenever a business deal is contracted for.
Net income. This phrase sounds good, but when it consists mainly of non-cash items and inventory it is practically a worthless equation for cash flow calculations.
Free cash flow, operating cash flow, and net cash flow are subsets of the same concept, but the bottom line is they all give the business owner a concrete idea of where their business stands at the end of the day — in the red or in the black.
Staying on top of cash flow issues is not always easy for a business owner; they are also caught up in marketing, advertising, production, distribution, and customer service. Since one business owner can’t be everywhere at once, some priorities must be set and a regular, though flexible, schedule observed so that each segment of the business get the attention it needs and is not left to drift unattended. The majority of successful small business people insist that cash flow should be one of the top priorities, no matter what. As long as the cash flow acts like a stream of water or small river, steadily moving on and under control, most moderately intelligent business owners can spend as little as an hour or two a day on it. But if the cash flow is neglected or abused it is likely to become a raging torrent that threatens to run out of control — ripping apart carefully laid financial plans and future growth strategies as everyone in the company drops everything else to put up sandbags of one sort or another to prevent a complete catastrophe.
Keep the following in mind for a steady and sane cash flow:
Know the company’s breakeven point
The breakeven point of a business is like a thermometer — it indicates if things are running smoothly or if there is a ‘fever’ spike that spells trouble for the cash flow in the coming weeks and months. An attorney with Versus Texas confirmed; “A breakeven point will constantly vary from day to day, so use the best accounting tools you can to keep track of it.”
Remember that cash flow is the foundation of any successful small business
This may seem unduly repetitious, but the statistics don’t lie; companies that neglect their cash flow situation and let it deteriorate most often find themselves out of business in a matter of months, if not weeks.
Keep some cash reserves on hand
Every small business experiences negative cash flows from time to time. Some can be planned for, especially in a seasonal business. But sometimes a negative cash flow occurs without warning, and if it lasts more than a few days it can seriously disrupt payments to employees, vendors, landlords, and other importunate entities that don’t like to be kept waiting and will often activate unpleasant penalties for tardiness. According to business financing firm Evolocity, “A cash reserve earmarked for just such emergencies will keep a small business in the good graces of everyone concerned with its continuing success.
The cash flow worksheet
Using modern accounting algorithms, a cash flow worksheet, like Microsoft’s Cash Flow Statement, is a good way to stay on top of the cash flow situation of a small business. Just be sure to keep the entries up to date.
In conclusion, motivate quick payments
One of the best ways to lower financial risk, and to increase your stature at the bank, is to encourage customers to pay their bills asap. A small business that simply sends out the bills and then waits thirty days before following up on them is losing a lot of potential money. Give customers some kind of token or gift item for paying within ten days of receipt, and make sure the payment process is available online and is hassle free. The more payments a small business can process in a timely manner, the better the cash flow is going to get.