A Guide to Cash Flow and Why it is so Important for Small Businesses
Keeping a pulse on your cash flow is vital because it tells you how healthy your business is overall. Understanding cash flow is critical for small businesses; knowing how much money is coming in and out every month helps business owners identify potential shortcomings and areas for growth. Read on to learn more about cash flow and how understanding it can help change the trajectory of your business’s growth.
What Is Cash Flow?
Cash flow is the total amount of money that flows in and out of a company annually. It sounds simple, but there’s more to understanding cash flow than meets the eye. Cash flow accounts for all of a business’s earnings and spending; it enables business owners to see if their company is profitable enough to expand or if they should dial it back because they’re going through a dry sales period.
Cash flow is all about keeping an eye on the big picture. For example, a small business with low cash flow might appear profitable in proportion to what they’re spending, but that doesn’t necessarily mean it’s a good time for them to go on a hiring spree. On the other hand, business owners who fail to recognize an increase in profit and overall cash flow might miss out on opportunities to aggressively expand their business.
Accounts Receivable Versus Accounts Payable
One of the first steps to understanding your business’s cash flow is to know the difference between accounts receivable and accounts payable. Basically, accounts receivable represents a company’s assets, which include things like cash on hand or a positive bank balance. On the flip side, accounts payable focuses on a business’s liabilities, including debts and other payments it owes.
Accounts receivable: Your business’s accounts receivable is an asset account that tracks all the money going into your business. This money includes incoming funds from customers for the goods or services you sell. Keeping track of your accounts receivable account will help determine your business’s profitability.
Accounts payable: Your business’s accounts payable is a liability account that tracks your expenses. This account keeps track of all the money your business owes. Items like bank loans, business expenses, and payroll fall into this category.
Determining the Profitability of Your Business
Keeping a close eye on your accounts receivable and accounts payable will help you determine the profitability of your business. To forecast how profitable your business will be, you can add up all your assets, including those in your accounts receivable, and subtract that amount from your accounts payable.
If your calculations result in a positive number, your business is profitable. If you receive a negative number, it is time to start looking for ways to increase your potential profitability.
What Is the Difference Between Profit and Cash Flow?
People often confuse profit and cash flow with each other; however, there are slight differences between the two. Profit and cash flow are not interchangeable, mainly because cash flow focuses on the balance in your business bank account. In many cases, business owners can start to turn a profit but still have a negative cash flow.
For example, the cost of making a product is usually cheaper than what a business sells it for, but even if a company earns a 25% profit on every item they sell, it could still have more expenses than income. In this scenario, the business still has a negative cash flow.
Why Is Cash Flow so Important for Small Businesses?
Cash flow makes the world go round when it comes to doing business. Having positive cash flow means you’re doing things right, and your business is growing; that extra money to put aside will make things easier in the long term. Steady cash flow enables business owners to pay for expenses as they come and handle any roadblocks that might happen along the way. If you’re going through a dry spell and cash is only trickling in, you might run into some issues.
1. Helps Future Financial Planning
Keeping a close eye on your cash flow is vital for planning ahead financially. Knowing the precise amount of money you have at any moment will allow you to accurately forecast your income and expenses and plan for the future. If you neglect your incoming and outgoing cash flow, you can put yourself at risk of making poor decisions that hurt your business. If your cash flow statement is not up to date, you should avoid making any large purchases until it is.
2. Understand Where Your Money Is Going
A firm grasp of your cash flow will give you a better understanding of where your money is going. For any business, it is critical to know where money is going and why it is going there. Understanding why you are spending money in certain areas is crucial because it can help you identify where you can afford to reduce costs.
3. Protects Valuable Business Relationships
No business can function without help from suppliers and other third parties. If your business is facing cash flow problems, you might be unable to pay your suppliers and partners on time. This could negatively impact your relationship with them and your company’s overall reputation.
One way to avoid missing payment deadlines is to set strict schedules. Scheduling payments will help ensure the business has the necessary funds available to pay suppliers on time. Planning can help you avoid falling behind on multiple bills and invoices.
4. Allows for Business Growth
Most importantly, your cash flow informs when you can grow and expand your business. Expansion for your business could mean breaking into new markets, hiring new staff members, and generating more revenue for future endeavors. Understanding cash flow will help you feel when the time is right to expand. If you fail to do your due diligence and expand at the wrong time, you might make a costly mistake.
Growing your company requires a lot of capital. Acquiring assets, hiring employees, and renting office space are all items that require a hefty sum of money upfront. If you fail to plan and dive in without knowing if you have the cash available to match your growth, it could all be for nothing. Cash flow is critical for any business– you should never jump into anything without knowing if you will come out on top.
Understanding and keeping a pulse on your business’s cash flow can help you to make better decisions and plan for the future. At Mantis Funding, we provide revenue-based financing for a variety of industries. We offer funding from $5,000 to $500,000 and flexible repayment plans. Contact us today to get started!
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