When running a business, the importance of cash flow cannot be understated. While profits, sales and expenses are all important to keep an eye on, cash flow is perhaps the most important.
The problem with just looking at sales or profits is you can’t see the full picture of your current finances.
Monitoring cash flow, on the other hand, is an essential part of keeping a business running smoothly. In some ways, this is why cash flow is more important than profit.
Below, we discuss some of the top reasons why cash flow is important for small business success.
What is cash flow?
The first question you may have is what is cash flow? Cash flow is simply the flow of money coming in and going out of a business. It should not be confused with profit or sales.
Having positive cash flow means that there is more money coming into the business than leaving it. If you have negative cash flow, it means more money is leaving the business than coming in.
The problem with negative cash flow is that it can be difficult to cover your expenses and keep the business afloat. That’s why cash flow can make or break a business. It’s possible to have relatively high sales figures but still run into liquidity issues and lack funds.
How big businesses manage cash flow
Cash flow has become a worry for many businesses the past year due to COVID-19. So much so that some of the biggest tech giants are still sitting on mountains of cash to help them ride out the crisis.
Apple, Microsoft, Alphabet, Facebook and Amazon are all holding huge amounts of cash to withstand the crisis. Apple leads the way, reporting $191.83 billion in cash reserves from the fourth-quarter of 2020.
It sounds easy enough for big businesses to round up the cash reserves, but what about smaller companies?
In some ways, it’s even more important for smaller businesses to keep an eye on their cash. But why is cash flow important to small businesses in particular?
Big businesses that have been around for a long time will have much bigger cash reserves anyway. That’s largely why we’ve seen smaller businesses fall and large companies thrive during COVID-19.
With smaller and new businesses less likely to have this back-up plan, it’s important to be especially careful with cash flow.
Why cash flow is key to business success
A mistake that a lot of new businesses make is just looking at the sales. The problem here is that many businesses don’t receive payment immediately after processing a sale.
You could invoice a client for work and not receive payment for months. In the meantime, you still need to pay the bills, suppliers and staff salaries. Without factoring this in, you could quickly fall into a big cash flow problem.
In fact, poor cash flow is one of the top reasons why small businesses fail.
Paying suppliers and staff is not the only thing to consider though. Here are some of the other reasons why cash flow is important to a business.
1. Cover short-term debt
Most businesses have some kind of debt and the key to keeping up with repayments is good cash flow. Good cash flow ensures your business can pay suppliers and staff on time. Therefore, cash flow is really important in maintaining good business relationships.
2. More negotiating power
Having the cash to spare to make purchases without credit or financing puts you in a much stronger position. You may even be able to access more favourable trade terms with suppliers if you can pay upfront without needing credit.
3. Expand and seize opportunities
When the time comes to expand your business or invest in new avenues, positive cash flow is a must. For example, if you are looking to open a new online shop, you would struggle to do this if you had poor cash flow.
4. Access finance when needed
While cash flow can help you avoid taking out finance, sometimes you may need a business loan anyway. If your cash flow is positive, this makes it far easier to get accepted for credit.
Having good cash flow shows that you will be able to meet all the repayments on time. It might also make it easier to get better loan terms, for example, lower interest rates.
5. Easier to navigate downturns
Business is anything but plain sailing all the time. Sometimes a business will hit a rough patch or face economic downturns.
Having enough money in the bank during a downturn gives you peace of mind that you can get through it. This will make it much easier to get back on your feet when the business picks up again and things return to normal.
6. Improved planning and decision making
A steady stream of cash not only helps you build good cash reserves, but it also makes it easier to make plans.
Any plans for future growth and expansion will rest on your business’ flow of cash. Positive cash flow makes it much easier to plan without the fear of paying the bills. It also means you can take the time to make strategic, long-term decisions that will grow the business in the future.
7. Create a more valuable business
If one day you decide to sell the business, any potential buyer will look closely at the cash flow. The same goes for any investors you wish to work with.
Before they buy your business or invest, they will want to know how successful the business is first. Cash flow and profits will be crucial factors in their decisions. The better the cash flow, the more valuable your business is.
How to ensure healthy cash flow
With all that in mind, how you approach cash flow management is key. Some steps you can take to better manage your cash flow include:
- Prepare Cash Flow Statements and Conduct a regular cash flow analysis: Cash flow statements can give you insight into the cash inflows and outlooks of your business as well as your cash position. Doing this at regular intervals throughout the year ensures you always have accurate information to make informed business decisions.
- Tackle late payments: Late payments are one of the biggest sources of cash flow issues. To tackle late payments, you could offer early payment bonuses as an incentive or even apply late payment fees as a deterrent. Another thing you can do is look at your bookkeeping software to see if there’s a way to make payments easier for your customers. For example, include a ‘Pay Now’ button on invoices.
- Make use of invoice financing: If late payments are a regular problem, you may want to use invoice financing or factoring. This is a method of patching up gaps in cash flow by getting an advance on unpaid invoices.
- Cash flow forecasting: Getting a cash flow forecast gives you a better idea of what your business’ future finances will look like. This can help you make plans in advance to ensure your cash flow remains positive.
If you need help with improving your cash flow management get in touch with one of our friendly accountants at BrooksCity. For more than a decade, we’ve been helping small business owners improve their cash flow and better manage their liquidity. To get a free consultation, request a quote here.