What is Cash Flow and Why is it Important?

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What is Cash Flow and Why is it Important?

We here at Fully Accountable can sum up the importance of cash flow with one statistic: 82% of businesses that fail do so because of cash flow issues. Care about cash flow yet?

This article discusses the reasons why cash flow is critical to any business looking to afloat. Cash flow gives you critical expense information and clearly displays whether you’re actually turning a profit or just thinking you’re turning a profit. 

The critical financial statement lets you know whether you can sustainably expand your business and it helps you analyze debt, protects your business reputation, and helps you maintain healthy relationships with vendors and lenders. 

Our full-service accounting experts are here to help you maintain your company’s success and expand your business in the most efficient, sustainable way possible. We understand your business is unique and that’s why we offer scalable, fractional services to meet your individualized needs.

At Fully Accountable, you’ll have access to finance professionals with your industry’s expertise when you need them most. Whether you simply need a controller to maintain a watchful eye on your finances or you need something more extensive like a fractional CFO, we can deliver. 

What Is a Cash Flow Statement?

Cash flow statements accurately display how a company spends its cash. Businesses often use it along with the Profit and Loss and the Balance sheet to assess the company’s financial health. 

Why Is the Cash Flow Statement Important?

The cash flow statement is the most accurate method for displaying a company’s financial health. Without it, businesses don’t know where they’re spending cash. If a business continues to neglect cash flow analysis, it can easily lose money and turn from profitable to a liability. 

Cash flow statements display your expenses, loan payments, and tax requirements. These numbers help the leaders within a company strategize for the financial future. It is a key report that ensures a business’s solvency. Without it, the risk of bankruptcy is imminent. 

Cash flow reports are integral for larger businesses, particularly those that use non-cash transactions for a substantial amount of their revenue stream. Profit and Loss statements simply don’t utilize enough metrics to form a complete outlook. 

Cash Flow Vs. Profit V. Petty Cash

Cash Flow 

Cash flow is money that your business spends. Simply enough, positive cash flow means you have more money than you have coming in. Negative cash flow means you’re spending more than you’re making. 

When conceptualizing cash flow it’s critical you understand that you can be turning a profit and still struggle due to low cash flow. Instances such as overspending or ordering too much inventory can evaporate your profit in a short duration. 

Faster growing businesses typically require higher cash flows so they can keep up with demand. If your business experiences this type of growth, it’s important to pay close attention to their cash flow statements. 

Profit 

Profit is the amount of money left after deducting costs from the revenue. The higher your profit, the better. If costs outweigh a business’s total revenue, the business is operating at a loss, which is unsustainable. 

Petty Cash 

Petty cash is the amount of money a business needs to make smaller purchases such as a team leader buying employees lunch or taking clients out to dinner. Even though these expenses are small, every financial transaction needs to be recorded to ensure the business’s success. 

Cash flow, profit, and petty cash are three of the most critical indicators of a business’s success and they are both dependent and independent. For example, you can’t sustain negative cash flow and remain profitable but you can turn a profit and still have cash flow problems. 

Regardless of their interoperability, these financial indicators are the essential determinants of a company’s finances and they determine whether your business can sustainably expand.

Profitable Businesses Can Go Bankrupt

The idea that a profitable business can go bankrupt may seem jarring at firs, so let’s take a closer look. 

You may have loads of customers purchasing products off your shelves. That doesn’t necessarily mean you’ll be able to pay all of your bills. Let’s say you sell $300,000 dollars worth of product on credit and you offer your customers 90-day terms. You also spend $70,000 on supplies that you have to repay within 60 days. 

Additionally, you have $50,000 on your lease, insurance payments, payroll, etc. Unless you have cash reserves, you won’t be able to pay all your bills. Even if you eventually pay off your debt, this process can take its toll on your reputation and credit, resulting in you sacrificing relationships with vendors, suppliers, and lenders. 

Why Is Tracking Cash Flow Important?

Keeping Up With Debt 

Maximizing cash flow management ensures your business stays ahead of all your debts. Debts can destroy both businesses and individuals and when you run a business, you typically accrue more debt than individuals. 

Both long-term loans and short-term credit accounts can restrict free cash flow, meaning you lose the ability to invest in your business’s growth. Staying on top of these numbers ensures you can adequately plan for your financial future, choosing the right credit options. 

Advised Decision Making

Accurate cash flow statements advise you so that you understand your financial health. When you look at an accurate cash flow statement, you immediately know your available funds. Any decision you make thereafter is made with accurate information. 

You may mistakenly believe that your business is in a strong position to aggressively expand while a cash flow statement says otherwise. It lets you gauge your purchases in the yearly, quarterly, monthly, and weekly time periods. 

Understand Where You Spend Money 

Understanding where you spend your money is a key component of the cash flow report. It should clearly display the outpouring of finances and you should be able to easily locate payment schedules to suppliers and you can see clear distinctions of necessary vs. unnecessary expenditures. 

Protect Business Relationships 

Cash flow problems cause issues when it comes to paying your suppliers, harming business relationships and damaging your business’s overall reputation. Cash flow reports direct you on the correct finances available you need to pay suppliers. Without these reports, your business runs the risk of losing its reputation over time. 

Expand at the Right Time 

Growth and expansion is an exciting business proposition. New markets, new employees, more money- what’s not to like?

However, done too hastily and without the correct logistics, expansion can kill businesses. Growth requires a hefty sum of cash. You need to consider increasing inventory, rent, and payroll. If your funds don’t match your growth, your growth will cause your demise. 

Managed Cash Flow Increases Opportunity

Cash flow is similar to debt management in the sense that it offers visibility into the areas of your business you can sustainably invest in for growth. 

Building new locations, investing in research and development, renovating infrastructure, and improving technology are all great ways to expand your business. However, if you expand these areas without the proper due diligence, they will hurt you more than help.

Conclusion- What Is Cash Flow and Why Is It Important?

Cash flow is an integral component to the success of every business. Without it, finances quickly become murky, making it difficult to decide whether business decisions are right or wrong. 

Thoroughly planned cash flow statements give you financial diagnostics that aid every facet of your business. They tell you when to expand and when to cut costs, protect your reputation and business relationships with vendors, and most of it all , make it clear where you’re spending your money. 

The experts at Fully Accountable can keep track of all your finances so you can focus on your core business principles. We are your business partner on the road to your financial success and sustainable growth. 

Contact us today to learn what Fully Accountable can do for your business. 

Vinnie Fisher

Author at Fully Accountable | 1-877-330-9401 | www.fullyaccountable.com

Vinnie fisher is an entrepreneur, author, husband, and father of 4. A lawyer by trade, for almost ten years, Vinnie focused on tax planning, corporate formation and operation of closely held businesses. Vinnie was a principal partner in his law firm that he wound down to pursue a career as an entrepreneur. After the creation of a series of successful internet and e-commerce companies, he discovered a much needed service for business owners. In 2014, Vinnie opened Fully Accountable, an outsourced accounting and finance firm for e-commerce and digital businesses. Today he serves as the CEO of the company. Fully Accountable a cutting edge firm that offers done for you services that includes everything from master bookkeeping to fractional CFO services. We are digital experts specializing in high transaction businesses. Our clients are all over North America. We offer a complete accounting back office for your business costing less than the price of an entry level person in your company. Our data analysts and accountants do the work and provide the proactive, forward thinking feedback you need to make the right decisions to increase your growth and double your profit margin.