Managing cash flow finance can become a difficulty for various growing and small businesses. According to many types of research, a majority of the businesses fail due to this problem. Not just a difference between expenditure and revenue, cash flow can be the difference between failure and survival. Therefore, in order to manage it properly, you first need to understand what it means and why should you care about cash flow banking.
What is Cash Flow Banking?
Cash flow finance is a widely-used way of measuring the financial position of a business. It is typically used in assessing applications for credit and loans when an institution needs to assess a customer’s credit worthiness and likelihood to pay the loan back.
A concept that lets a person capture the opportunity cost of their money rather than giving it to the bank is referred to as cash flow banking.
Cash flow refers to the money flowing in and out of an individual’s business in a month. Even though it looks like cash flows in only one direction, it flows in both directions.
- Cash goes out of the business as payments like taxes, mortgage or rent, in monthly loan payments, and other accounts payable.
- Cash comes in from clients or customers who buy your products and services. If they do not pay while purchasing, some cash flow comes from collections of accounts receivable.
You can calculate your cash flow by the given formula, keeping in mind the activities that contribute to outgoing and incoming transactions.
Why Should You Care about Cash Flow Banking?
You must care about cash flow finance since lack of cash can result in the failure of your business, especially if it is a small one. This is referred to as running out of money. You definitely do not want to run out of it when you have just started your business, do you? Following are the reasons why you should care about cash flow banking:
- Profit- Do you think it is possible for your business to make a profit but has no cash? Sounds hypothetical to you? While cash is only the amount in the business checking account, profit is a concept of accounting. You may have assets, such as accounts receivable, but if you cannot collect on what is owed, you would not have any cash.
A difference between profits and cash might even be shown by your accounting system. Although the customer has not paid, you will see income when the invoice is sent in case your business runs on accrual accounting.
- Seasonal Business-Cash flow is predominantly prominent for seasonal businesses – those that experience large fluctuation of business at various times of the year, like summer business and holiday business. Although dealing with cash flow in such type of businesses is tricky, it is not impossible – you can do it with carefulness.
- Initiating a Business-Managing cash flow problem is the most complicated when you are initiating a business. You have a lot of expenditure and money goes out fast. Moreover, you might not even have any customers or sales to pay you. Therefore, you might require other temporary sources, such as a temporary line of credit in order to make it a positive cash flow situation.
Analysing Cash Flow
Running a report on cash flow is the best way to keep a track on cash flow. The statement observes the change of cash from various business activities and augments or diminishes in other accounts on the business balance sheet.
- What happens to cash if you pay an independent contractor or an employee?
- What happens to cash if you purchase a computer?
- What happens to cash if your business purchases supplies?
- What happens to cash if a customer or client pays a bill?
Sometimes, you may even be in the requirement of keeping a daily or weekly track of the cash flow.
Ways to Manage Cash Flow in a Better Way
Following are the 7 ways in which you can manage the flow of cash in order to save or improve your business:
- Have contingency plan- Spread payments and do not invest everything in business.
- Free up cash reserves- Back-up plans are crucial.
- Efficiency is the key- Manage inventory and stock efficiently.
- Be professional- This will help you in being paid on time.
- Be organised- Cash flow forecasts are important.
- Check for creditworthiness- In case of large orders from customers, ensure that they will pay.
- Manage late payments
- Emphasise, firmly but politely, legal requirements to meet terms.
- Make sure that your payment terms are clear.
Consequences of Cash Flow
Cash flow can be both positive and negative. The outcomes of these differ:
- Positive Cash Flow: Positive cash flow finance depicts that the business can effortlessly meet the requirements of the company for all operations of expenditure. Plenty of cash in the business is never idyllic since there may be lost chances for investments. It is critical to strike a cash flow optimum.
- Negative Cash Flow:This simply means that more money is spent on expenditures compared to the money coming in. This is likely to have a negative impact on the business. A negative cash flow may involve an augmentation in borrowing with associated costs et al. Nevertheless, not all negative cash flow finance can be considered face value since there might be examples where large amounts of investments need companies to report on such cash flows for a certain term.
Cash flow mainly refers to the difference between expenditure and revenue. Businesses need to make sure to monitor their expenses to avoid overspending without the ability to finance the costs for longer terms.