A business’ cash flow is just as important as the merits of its products or services. A business with a superior value offering has the potential to fold if it has insufficient cash flow. Business owners and managers who prioritize cash flow give their company the best chance to remain operational and win the marathon as opposed to the short-term sprint.
A Brief Explanation of Cash Flow
Cash moves in and out of businesses similar to the gasoline used to power an automobile. If too much cash flows out of the enterprise and there isn’t sufficient cash flowing in, it will become difficult for the business to make payroll and cover overhead expenses. In short, cash flow is best defined as the net balance of dollars that move in and out of the company.
Cash flow can be either negative or positive. Positive cash flow occurs when the business has more money coming in than flowing out. Negative cash flow occurs when the business has more money flowing out than in.
Types of Cash Flow
The overarching term of “cash flow” encompasses cash from operating activities, the net change in cash, free cash flow to the firm (FCFF), and free cash flow to equity (FCFE). The net change in cash is the change in the cash flow between accounting periods. Cash from operating activities is created as a result of the primary business activities as opposed to investing.
FCFE is the cash available to the company following the reinvestment of cash into the enterprise. FCFF is a measure that assumes there is no debt. This type of cash flow is helpful in financial valuations and modeling.
Cash Flow is the X-factor of Modern Business
Cash flow is a picture of the company’s financial standing in the context of cash at a specific moment in time. A business that lacks positive cash flow cannot cover its financial obligations. Alternatively, a business that is cash flow positive will continue to operate without the prospect of insufficient cash crippling operations. A company that runs out of money will close its doors and halt operations due to the inability to pay employees and satisfy financial obligations. This is precisely why every business owner and manager should emphasize the importance of positive cash flow, sacrificing as necessary to maintain a net positive cash flow.
A slightly positive net cash flow will not suffice. Businesses need a considerable sum of money to remain fully functional as unexpected expenses are bound to arise. If you own or manage a business that is short on cash, it is in your interest to consider taking out a temporary line of credit to prime the cash pump should a situation arise where you need cash to cover unexpected expenses.
Cash Flow is Especially Important in a Business’s Infancy
The initial year of operation is an especially important period of time for business cash flow. If a business doesn’t have the cash necessary to survive this initial period of time, it will be challenging to stay afloat. The option of taking out a line of credit for the business in the initial six months or year might not be available simply because of the lack of credit history.
Furthermore, some customers will insist on paying with credit, making it that much more difficult to remain cash-flow positive. Prioritize your company’s cash flow, keep an eye on this important metric of success, and pivot accordingly as your cash flow changes in the months and years ahead.
Embrace the Challenge of Managing Cash Flow
Cash flow is nothing to fear. Rather, cash flow should be viewed as an important tool that helps your business realize its full potential. Your business can sidestep a cash flow emergency with the right cash flow management strategies. Prepare accordingly and your enterprise just might sidestep a cash flow shortfall that would otherwise render you unable to pay your hardworking staff, materials suppliers, and other parties essential to your company’s continued operations.
Take some time to analyze your business relationships to identify those that are unprofitable. If parties are not paying you in a timely manner or in full, make them aware of the outstanding balance by sending a follow-up bill. If necessary, cut ties with businesses that fail to pay, those that fail to pay on time, and those that do not pay in full.
Though it is uncomfortable to ask for money owed for services or products rendered, doing so is a necessary component of the business. You can collect receivables much more easily by implementing a collections schedule. Set up an account receiving report that details aging so you can easily and accurately track the money owed to your business. Those who fail to pay their bills on time should be made aware of the money owed as many times as necessary. Follow up with these non-payers until they pay or outsource the work to a collections agency.
Managing cash flow is that much easier when you maintain control over inventory. If you have an excess of inventory, your company’s limited cash will be tied up in products that should be on store shelves and generating additional cash for the organization. Track your inventory as time progresses and you will be able to estimate your company’s needs that much more accurately, ultimately helping you maintain positive cash flow.