No business can afford to ignore their cash flows. Watching this is like keeping track of your heart rate – it’s a critical check on the health of your business. Moreover, more than a third of SMEs cite cash flow problems as an obstacle to their growth.
It is very important to understand what your cash flow is, how to calculate it, in order to keep abreast of events.
What is Cash Flow?
Monetary flow is the movement of money in your business in terms of income and expenses. Ideally, you want to have a positive monetary flow – this means that more money is going into the business than it is going out. If you have positive cash flow, your business can pay off its bills and invest in growth. A negative cash flow means that you will need to find an alternative source of income in order to be able to pay off your debts.
What happens if you don’t keep track of your cash flow?
Failure to monitor and manage your cash flow properly puts your business at risk and can lead to a variety of different problems. Here are some of the main problems you may encounter:
- Too much inventory. If you suddenly get a high demand for a product, it is tempting to order a large volume of material to meet that demand. However, if this demand changes, you may have too much inventory and possibly debt due to ordering materials. Ordering too much inventory can also result in you being overwhelmed with materials that become obsolete and difficult to sell.
- Long terms of payment. Due to the long payment deadlines when no money arrives, you often have long periods of time. Any invisible problem, from an office fire to a laptop replacement, can become problematic due to a lack of cash while you wait for money to arrive. There is also the likelihood of bad debts when clients do not pay at all.
- Overrun. When you have a new client, it can be tempting to spend money on everything from trendy orthopedic chairs to an office table tennis table. However, you must remember that you don’t actually have money until they pay you. Spending money that you don’t have is never a good idea.
- Excessive trade. As in the case of warehouse stocks, after a large order it is easy to get carried away by the prospects of your business. Hiring more employees or expanding to more jobs may seem like a good idea to grow your business, but you need cash flow to support it. While your bottom line may change, your rent and salary will not change, which means you need to be able to withstand short-term pressure on your finances if you want to increase your staff and premises.
Now that you know that monetary the flow is important information, it is worth understanding how it can be calculated. If you want to calculate net cash flow, you simply add up all your cash payments for a set period (usually a month) and subtract them from your cash receipts. However, it’s important not to get too hung up on one particular month. Your cash flow can be more accurately estimated over a period of three months or more, since most businesses naturally have peaks and valleys.
While your turnover can be a fairly large number that gives you confidence that your business is doing well, it’s cash flow that gives you a better understanding of how well your business is being managed. As the old adage goes, turnover is vanity, profit is sanity, and cash flow is reality.