Cash management basics
Business analysts report that poor management is the main reason for business failure. Poor cash management is probably the most frequent obstacle for entrepreneurs. Understanding the basics of cash flow will help you plan for unforeseen eventualities that almost all businesses face. Here is some helpful information on the importance of cash management for your small business.
Box vs. Cash flow
Cash is money available in the bank or in the business. It is not inventory, it is not accounts receivable (what is owed to you), and it is not property. These can be converted into cash, but cannot be used to pay vendors, rentals, or employees.
Earning growth does not necessarily mean more cash on hand. Profit is the amount of money you expect to make in a given period of time, while cash is what you must have on hand to keep your business running. Over time, a company’s profits have little value if they are not accompanied by positive net cash flow. You cannot spend earnings; you can only spend cash.
Cash flow refers to the movement of cash in and out of a business. Keeping an eye on cash inflows and outflows is one of the most pressing management tasks for any business. The cash outflow includes the checks you write each month to pay wages, vendors, and creditors. Inflow includes the cash you receive from customers, lenders, and investors.
Positive cash flow
If its cash inflow exceeds its outflow, a business has positive cash flow. Positive cash flow is a good sign of financial health, but it is not the only sign.
Negative cash flow
If its cash outflow exceeds the inflow, a company has negative cash flow. Reasons for negative cash flow include excessive or obsolete inventory and poor collections on accounts receivable (what your customers owe you). If the company can’t ask for additional cash right now, it may be in deep trouble.
What are the components of cash flow?
A “Cash Flow Statement” shows the sources and uses of cash and is typically divided into three components:
- Operating cash flow: Operating cash flow, often referred to as working capital, is the cash flow generated by internal operations. It comes from the sales of your company’s product or service, and as it is generated internally, it is under your control.
- Investment cash flow: Investing cash flow is generated internally from non-operating activities. This includes investments in plant and equipment or other fixed assets, non-recurring gains or losses, or other sources and uses of cash outside of normal operations.
- Financial cash flow: Financial cash flow is cash from outside sources, such as lenders, investors, and shareholders. A new loan, the payment of a loan, the issuance of shares, and the payment of dividends are some of the activities that would be included in this section of the cash flow statement.
How to practice good cash flow management?
Good cash management is simple. It involves:
- Know when, where and how your cash needs will occur;
- Know the best sources to meet additional cash needs; Y
- Be prepared to meet these needs when they occur by maintaining good relationships with bankers and other creditors.
The starting point for good cash flow management is the development of a cash flow projection. Smart business owners know how to develop short-term cash flow projections (weekly, monthly) to help them manage daily cash, and long-term cash flow projections (yearly, 3-5 years) to help them develop the capital strategy necessary to meet your business needs. They also prepare and use historical cash flow statements to understand how they used money in the past.
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