Cash is a vital part of every business. As the saying goes, “Cash is king.” Having no cash signifies that there is no business. Cash is needed in making purchases for your enterprise, employing personnel, and in promoting your business, among other things. It is created through investments, loans, and purchase of your product, service, and/or assets. When there is acquisition of assets, business outlays, and/or credit or loan settlements, it is said that cash flows out of the business.
Cash versus Profit
Some people get confounded with cash and profit. Cash denotes the quantity or the amount of money, which can either be in the form of bank deposits, foreign currencies, coins, or notes that your business has access to. On the other hand, profit amounts to your business’ earnings and its associated costs, and are typically evaluated over a definite time frame. Interestingly, a lot of enterprises break down due to dearth of cash rather than shortfall in profit.
What is Cash Flow?
The movement of cash into and out of the business is termed as cash flow. When an enterprise creates revenues, there is an inflow of cash. If the business makes expenditures, there is an outflow of cash. It is advised that business owners should track their cash flow on a regular basis.
To illustrate the importance of cash flow, let’s say that an enterprise is involved in selling heavy equipment. The business markets machineries for $50,000, which can be paid within a month. This translates to$50,000 in revenues. However, the cash hasn’t “flowed” yet. If the business spent $30,000 in assembling or manufacturing the equipment, the company will earn $20,000 in profit. But, it will take a month before the company will actually have its profit. On top of that, the company has to pay its employees, personnel, and suppliers the $30,000 it spent on manufacturing the equipment. Where will they get this money? For a business to survive, cash flow is needed.
Types of Cash Flow
The example shown above introduced us to the types of cash flow. These are positive cash flow and negative cash flow. According to inc.com, positive cash flow takes place when an enterprise’s cash inflow is greater than the cash outflows. A positive cash flow indicates that the business is doing well. With this, the company can settle their liabilities, further their enterprise through investments, and can save for the rainy days.
On the contrary, negative cash flow occurs when cash outflow is much larger than the business’ cash inflow. This means that the company is spending more than what they are receiving. As much as possible, business owners should avoid negative cash flow. However, even if the company performs due diligence, there will always be a time when negative cash flow will ensue. This will be quite troublesome, especially, for business startups.
Classification of Cash Flows
A business’ inflows and outflows can be classified into operating, investing, and financing activities. A preponderance of an enterprise’s cash flows is from operating activities. It creates cash flows (inflow and outflow) from the products and/or services being sold, and from general business expenses such as procurement of supplies. This classification of cash flow depicts the business’ daily activities.
Cash flow from investment activities pertains to the acquisition and selling of the company’s fixed assets. Moreover, cash flow from financing activities is created through investments from financial institutions (e.g. lenders) in the form of loan or credit.
Projecting Your Cash Flow
Determining the sources and amount of cash inflows and the destination and amount of cash outflows over a definite time frame is called cash flow forecasting. It lets businesses foresee the peaks and troughs of their cash balance.
It is ideal that enterprises include cash flow projections in their budgeting process. Cash flow forecasting serves as an indispensable tool in anticipating cash flow deficits and surpluses. In addition, banks usually require cash flow projections before they approve loans.
Managing and Improving Your Cash Flow
For a business to survive, business owners should employ effective cash flow management. Tracking your inflows and outflows is a good way to start. Maintaining your inventory and managing the account payables and receivables can improve your cash flow.
Evaluating your business regularly in order to eliminate needless expenditures is also good for your cash flow. To ensure continuous inflow of cash, you should issue invoices promptly so that your clients will be able to pay you pronto. Business owners can also opt to introduce various payment schemes to their clients. To increase cash, businesses should attract new customers. This can be achieved by introducing new lines of products or giving discounts.
For cash flow problems that need immediate solutions, business owners can secure loans or consider line of credit from financial institutions.