Don’t Kill Your Business — The Importance of Cash Flow
"Growing your business puts a huge strain on cash […] you almost always have to make investments and bring certain expenses on ahead of achieving the higher revenue and cash flow that comes with successful growth."
Cash flow is one of the most critical components of success for startups and small to medium-sized businesses. Without cash, profits are, by and large, meaningless.
This is because profits (or indeed losses, if you are trying to reduce taxable income) can be manipulated and do not always represent the fact that more cash is coming in than going out.
Firms that do not exercise good cash management may not be able to make the investments needed to compete, or they may end up having to pay more to borrow the money to function.
As Philip Campbell writes in his book, Never Run Out of Cash:"Most business owners don’t truly have a handle on their cash flow… Poor cash-flow management is causing more business failures today than ever before."
Cash Flow Basics
Cash flow is the term used for the cash inflows and outflows of your business. If you have a positive cash flow, your business is receiving more cash than it is spending (where we all want to be). Conversely, if your business is spending more than it is earning you have a negative cash flow.
Positive cash flow isn’t a happy coincidence as a result of your business doing well; it requires regular analysis and management. If you do not wish to work with an accountant, I would recommend using a good accounting software, such as Xero, which will allow you to run cashflow reports, see the bigger picture and delve into the detail where necessary.
Why Doesn’t Profit Reflect Cash Flow?
Your bottom line is not a good indicator of your cash flow. Profit (or loss) takes non-cash items into account such as receivables or payables (where the cash has yet to be received or spent) as well as depreciation, amortisation and various other accounting adjustments.
Getting Control of Your Cash Flow"Most business owners see growth as the solution to a cash-flow problem. That’s why they often achieve their goal of growing the business only to find they have increased their cash-flow problems in the process."
Campbell recommends asking yourself the following two questions to ascertain whether you have your business’ cash flow situation under control:
1. What is my cash balance right now?
2. What do I expect my cash balance to be six months from now?"If you can’t answer these two questions, then strap yourself in for a wild ride. You are on a roller coaster ride that’s about to become really frightening. You don’t have your cash flow under control."
One way to keep that situation under control is by tracking your cash flow results on a monthly basis to determine if your management is creating the type of cash flow your business needs.
This will also help you get better and better at creating cash flow projections you can rely on as you make business decisions about expanding your business and taking care of your existing bills.