If you are a business owner, ensuring a steady, dependable flow of revenue is one of the most important things you need to master.
The reason for that is simple. Without a steady stream of income, it becomes impossible for any company to function in very short order. After all, employees, landlords, and suppliers all expect to be paid.
In fact, ask just about any small business owner about what problems they face, and cash flow will likely be at the top of the list. In fact, the problem is so prevalent that, according to the Small Business Administration, poor cash flow accounts for 82% of all small business failures.[1]
How do you tackle this problem? PNC Bank’s Shana Peterson-Sheptak, Head of Business Banking, has some useful advice.
“There’s no question about it. Cash flow is the lifeblood of any business,” she offers. “It requires constant attention, a balancing act of staying on top of receivables and payables. Plus, it helps to have expertise and the right financial tools available during the lean times.”
As Peterson-Sheptak advises, always understand and analyze your accounts receivables aging to understanding where you can improve. Weekly or monthly reports are key.
“How old is your debt getting out there? Are there customers who don’t pay on time?”
What IS Cash Flow?
Simply put, cash flow is the income that comes into the company from various forms of revenue and exits the company through the payment of expenses and other obligations.
At all times, a small business owner should aim for positive cash flow, the holy grail for any business. Positive cash flow means that your liquid assets are increasing over time, with more money coming into your business than leaving it.
With positive cash flow, you can cover expenses and repay debt, invest for future growth, and pay returns to shareholders. At the same time, positive cash flow gives you the ability to build reserves to meet any future financial challenges as well as capitalize on any investment opportunities.
While negative cash flow means that you’re spending more than you’re earning, it is not always a sign of trouble. Instead, it could indicate that you’re investing in growth. However, it’s important to pay strict attention to negative cash flow to make sure you have enough cash on hand to get through lean times, as well as pay suppliers and vendors.
What Are The Types of Cash Flow?
Cash flow isn’t just about direct sales. Instead, you can derive income from any number of sources, including interest income, investment income, royalties, and licensing agreements. In addition, cash flow can also take the form of products sold on credit with the expectation of customer payments at a future date. Cash flow typically falls under three broad categories:
Cash Flows From Operations (CFO). When most people think of cash flow, this is what comes to mind. Cash flow from operations is derived from the production and sale of goods. It is the common measuring stick to indicate whether a company has enough incoming cash to pay bills and operating expenses.
Calculating CFO is a matter of taking cash received from sales during a specific period and subtracting operating expenses from that same period. This calculation should be recorded on a company’s cash flow statement on both a quarterly and annual basis. This provides a good barometer of your company’s current financial state, signaling when you may need additional financing to maintain operations.
Here, it’s important to differentiate between Sales and Cash Received. If a company has made a sale but has not yet received payment for the sale, then that sale has not yet made a positive impact on the company’s cash flow.
Cash Flows From Investing (CFI). Not all cash flow comes from direct sales. Instead, a company may derive revenue or have expenses from investments such as the purchase or sale of speculative assets and securities. In this situation, negative cash flow could result from cash invested for the long-term health of the company such as Research and Development. So, especially when reviewing CFI reports, it’s important to realize that not all negative cash flow is a cause for concern.
Cash Flows From Financing (CFF). Loans to the company. Investment capital. Dividends paid to investors. These are all instances of cash flows from financing (CFF), revolving around those transactions that entail debt, equity, and paying dividends.
What Is Free Cash Flow (FCF)?
If you have debt or investors, Free Cash Flow is the money you have available to repay a creditor or pay dividends to investors. It also provides a good snapshot of your company’s value and its overall health.[2]
For example, if accounts payable (The money being paid out) is decreasing over time, it could signal that your vendors require faster payment. Likewise, a decrease in accounts receivable (Revenue coming in) could mean the pace of your collections are picking up. And a buildup in inventory is a sign of unsold products.
What’s The Difference Between Cash Flow And Profit?
Contrary to what many may think, cash flow isn't the same as profit. It is an understandable mistake. However, the two are distinctly different concepts.
Cash flow is the money that enters and exits the business. Meanwhile, profit is the overall measure of a company’s financial success, showing what money is left over after a company pays its expenses and obligations.
The distinction can be most apparent when it comes to a company’s income statement. If a company’s income statement operates on an accrual basis, for example, it measures money that has been billed to customers, not money that has been received from customers. So, a company’s income statement could show a profit on paper yet be starved for cash if it has not received payment.[3]
How Do I Analyze Cash Flow?
Staying on top of cash flow analysis is safeguarding your future operations. Fully understanding your upcoming revenue and expenses helps to anticipate future needs, make adjustments, pare spending, and obtain additional capital well in advance of when you need it.
Your cash flow can be analyzed using the cash flow statement, a standard financial report that speaks to a company's sources and usage of cash over a specified time period. Experienced corporate management, analysts, and investors use this as the essential tool to understand how well a business earns money to meet obligations and expenses.
Along with the income statement and balance sheet, the cash flow statement is the most important financial report your company can generate. With thorough, timely reporting, a cash flow report can help you anticipate any future cash crunch, as well as map out any important company initiatives.
If all this sounds daunting, remember that cash flow analysis helps you master the ups and downs of the business cycle. Further, it’s knowledge that can be built on over time. If you’re just beginning to learn the ins and outs of cash flow, a valuable resource will be your accountant, banker, or other financial professional. He or she will be able to walk through your first cash flow reports, pointing out areas of concern while helping you understand how best to use it as a forecasting tool.[4]
So, what measures can a business like yours take to stay capitalized? While cash flow management can seem daunting, Peterson-Sheptak breaks it down into five basic principles to follow:
Stay Lean
Yes, it’s easier said than done. As you grow the business, there will be the constant struggle between funding to support growth and keeping an eye on spending. The key? As Peterson-Sheptak offers, it’s a matter of having the discipline to establish an operating budget—and sticking to it.
“It’s so important to know what your monthly expenses will be, what you need to pay no matter what. When you have ongoing awareness of the minimum adjusted gross income you need to clear, it allows you to make smart decisions in terms of spending, billing, collections, and a good deal more.”
While it’s important to be an optimist, it’s also crucial to always make sure your budget reflects planning for unexpected expenses.
Always Safeguard Your Credit
Having good credit means paying your bills on time. Not just your rent, but every other bill, too. It makes for good relationships with the strategic partners you need and makes you an attractive borrower to a lender.
By the way, what’s the best time to approach a lender for a loan or the ever-important business line of credit? As Peterson-Sheptak points out, it’s when your income statement is firmly in the black.
“You don’t want to apply for a loan when you’re having serious money troubles. Lenders want to see a well-managed business that demonstrates financial stability. When late payments start to crop up on a company’s credit record, that raises concerns.”
Watch Inventory Like A Hawk
The less control you have over the inventory you buy, store, and sell, the more the costs add up. But too many companies lack any kind of reliable inventory control system—43% of all small businesses, in fact. Unneeded inventory crowding shelves, expired inventory, back orders, and rush orders are all symptoms of a problem with a straightforward solution.[5]
“There are plenty of systems out there to help you manage inventory,” explains Peterson-Sheptak. “With the right system—and a commitment to using it—you’ll avoid a lot of the pitfalls of poor inventory management.”
Have Money For A Rainy Day
There will be those times when the economy sours or sales just slump for no good reason at all. As Peterson-Sheptak points out, it’s important to have access to enough capital to see you through.
“We recommend having the ability to get through several months of downturn. It might take the form of reserves in a savings account, a line of credit, or using your personal assets. But the key here is to survive until conditions improve. And a good plan today is better than having to scramble for cash when you need it most.”
Have Experts In Your Corner
You’re always looking ways to cut costs when it comes to operations. However, having the right professionals in your corner is almost always money well spent. A knowledgeable Certified Public Accountant (CPA) will prove an asset to your business—and not just when it’s time to fill out the tax returns.
“Cash flow problems don’t happen overnight. Instead, they result from weeks upon weeks of inattention,” Peterson-Sheptak observes. “It pays to have your accountant monitor your financial condition throughout the year. Not only does a good accountant bring insight and experience to the table, but they provide you with an objective eye, too.”
At the same time, she continues, a strong banking relationship is also key.
“We’ve found that, nine out of ten times, a customer who asks for a loan really needs cash flow solutions. And those are not always loans. Our bankers are trained in cash flow certification, understanding various types of industries and challenges for a small business. That allows them to offer products beyond extending credit, such as merchant services or treasury management or other solutions.”
Are you ready to get a handle on your business’ cash flow? Doing so might make the difference between growing the business of your dreams or dealing with the ongoing stress of making ends meet. Master these principles, and you’ll be putting your business on the road to growth.
