Cash Flow: The Foundation Of Business

money management

It costs about 5.5 cents for the government to make a dollar bill. It’s too bad you can’t buy them wholesale because cash is the lifeblood of every entrepreneur.

Julie Brander, a business consultant and former professor, explained during an interview with the U.S. Small Business Association in 2013 that “cash flow is the single most important aspect of your business because it focuses on the actual cash that goes in and out of your company.” This is why colorful financial pundits use the phrase “hemorrhaging cash.”

The Basics Of Cash

Cash flow is a simple term to grasp. It describes exactly what it is: the flow of cash. But the specifics are a bit more complicated.

For a fledgling business or a business that’s neglected its fiscal mechanics, the most crucial aspect of your overall cash-flow understanding is knowing where your cash is coming from, otherwise known as your cash inflow, or receivables. Not knowing that is akin to walking through a forest blindfolded. You might make it to the out on the other side, but chances are you’re going to trip, fall and starve to death.

There are three places a business is most likely to get its cash, which will come in as receipts: investors, capital and profits. But let’s put profits aside for now. Understanding cash flow begets understanding profits — without knowing your cash flow, you can’t know your profits. What you need to know is where your cash is going. Payables, or debts owed, or the outflow of cash, will vary from business to business, depending on things such as its specific needs, functions and staff, but most can be summed up into two categories: wages and bills.

Reconciling the difference between cash inflow and outflow is how a business effectively operates. But long-term viability requires a plan to sustain that reconciliation (unforeseeable and uncontrollable market forces withstanding).

Projecting Your Receivables

A cash flow projection is a model to help businesses plan for the future by making educated, long-term assumptions about inflow and outflow. However, understand that projections are fallible. Markets will change, as will expenses, and to properly manage cash flow, the projections will have to change alongside them.

Existing capital will form the foundation of your inflow projections, with you adding on expected receivables on a monthly basis for however many months you want your projection to extend. If your business is already recording sales, carefully evaluate the history of volume and the frequency of payments to more accurately predict the amount of cash you’ll have on hand at any given time.

Not only will the projection give you a better sense of your long-term spending power, but it also will help you sooner identify any potential pitfalls that may damage your business. There are times when a business will need a cash infusion, and preparation can only hope to inspire confidence in the investors and whoever else you might lend from.

Projecting Your Payables

Improving the functionality of inflow projections will mean layering them on top of payable projections. But how do you project payables? Agents of Efficiency explains this through its Expense Tracker model, built for projecting payables, that business costs fall into three categories:

  • FIXED: Expenses that you can count on being constant, like your office lease, internet access and insurance. These expenses are easy to project because once you determine the initial monthly cost, it’s a safe assumption they’ll remain fixed. If they change, it’s likely you’ll be given advanced notice and can adjust your cash flow projection accordingly.
  • VARIABLE: These costs can change each month, which makes them a bit tougher to project. It also forces you to consider your spending more carefully. Some common variable costs are things like training, meals, travel and inventory.
  • SEMI-VARIABLE: These costs are generally stagnant but are subject to immediate change, like wages and professional services.

Your receivables and payables projections should occupy the same timeline. So if you project one for a year, make sure you do the other for the same amount of time. The true benefit of the inflow-outflow forecast is in determining your break-even point, where your total receivables equals your total payables; further determining what inflow is necessary for how long to become ultimately profitable; and then determining where you can improve.

Optimizing Your Cash Flow

A business that understands its cash flow is a business that can thrive. It can measure success, acknowledge shortcomings and predict certain problems — all the pillars that prop up any company that’s existed for more than a couple years. Optimizing cash flow, though, is the sort of proactive measure that turns surviving companies into flourishing ones.

There are several ways to streamline your cash flow. Paying close attention to your business and the industry space it exists in will allow you to tune your projections more accurately. But if you’re lacking the years of sales and expense data necessary to better project your cash flow, here are two simple suggestions: Improve your receivables and better manage your payables.

Improving your receivables means speeding up how quickly customers pay you. “You can offer a discount for COD (cash on delivery) or net 10 days; it could be 2 percent off for paying more quickly,” Brander suggested in her SBA interview. “Otherwise, the only way to get paid quicker is to call weekly and remind your customers that money is due and offer to take a charge card over the phone.”

There are also a few preemptive steps you can take to improve receivables, like requiring credit checks for new non-cash customers and being more prompt in issuing your invoices. Any way to streamline the payment process is a step towards a more efficient cash flow.

Optimizing your cash payables is a matter of managing due dates, staying in constant contact with your suppliers, and taking advantage of discounts.