Why Cash Flow Is Important & How to Manage It
Why Cash Flow is Important
Cash Flow is the money that’s flowing through your company; these are much known as Accounts Receivable and Accounts Payable. Accounts Receivable or Inflow Cash is when there is an increase of cash that came from transactions while Account Payable or Outflow Cash happens when there is a decrease of cash is the result of a transaction. Managing Cash Flow in a business is important for it allows you to keep track of all the expenses inside the company and its business life.
There are 3 types of Cash Flow in a business.
1. Cash Flows from operating activities.
These include the cash activities related to the net income.
- Cash sale (goods or services)
- Cash receipts from commission, fees and royalties income etc.
- Cash payments to workers or employees in form of salary or wages.
- Cash payments to supplier of goods or services.
- Cash receipt on account of insurance premium by insurance companies.
- Cash payments in form of claims, annuity and other benefits.
- Cash payments or refund of income tax in case not included in investing or financing activities.
- Cash payments on account of current and future contracts.
2. Cash Flows from Investing Activities
These are cash activities that are dedicated to non-current assets.
- Cash payments to acquire tangibles and intangibles assets including construction of assets and capitalization of research and development costs.
- Cash receipts from the sale of investments and disposal of fixed assets.
- Cash payment for investments in shares, warrants and debentures of other companies etc. excluding those which are covered under cash equivalents or purchased for trading purpose. If so, those come under operating activities.
- Cash received from disposal of or sale of shares, warrants or redemption of funds other than those which are kept for trading purposes.
- Advances or loan made to third party other than by financing companies.
- Cash payment for future contracts other than trading purpose.
- Cash received from future contracts other than trading purpose.
3. Cash Flows from Financing Activities
These are non-current liabilities of owners’ equity.
- Long Term Debts
- Stocks and Sales Repurchases
Naturally there are problems you might face in analyzing business cash flows. As a business owner, you need to perform a cash flow analysis on a regular basis and use cash flow forecasting so you can take the steps necessary to head off cash flow problems.
Here are seven common cash flow problems that business owners face and sometimes create that can hurt their business and may lead to business failure. Some are tied to each other.
1. Overspending or Impulse Spending
This can happen at any time and can be particularly problematic when starting or expanding a business. You buy things you may not really need, certainly not right away. You don’t have enough cash flow coming in to offset expenses and you don’t conduct a critical cost-benefit analysis of your purchase.
2. Lofty sales projections
You dream about future success. You believe your great ideas, talents and services will generate a lot of business. Potential customers may not feel as strongly about what you have to offer or may defer decisions to spend on your offerings. Outside forces may impede your ability to sell your products and services. The reduced flow of money coming in may hamper your ability to pay for your overhead, let alone your personal living expenses.
3. Too much inventory
This is an offshoot of the first two problems. You tie up your capital in inventory. You may face storage costs as well. If you don’t sell your inventory quickly, you may need to discount the sales price or worse yet, write it off.
4. Unpaid invoices from clients
You may be slow in billing customers and collecting receivables. You may not be tough enough about payment policies, terms and penalties. You may not communicate effectively with customers upfront about paying you for products and services. You may not have tested policies and procedures in place to manage your customers’ credit.
5. Inadequate cash on hand
Any business can hit some bumps along the road. It’s not unusual for any business to have revenues that aren’t steady all year round. A slow period may mean that there isn’t enough cash to cover the overhead. If you don’t have a cushion of cash to cover your expenses, your business may suffer very quickly.
6. No funded contingency plans
Things happen. You get sick or hurt. Something happens to a key employee. Someone goes after your business when they suffer a loss or damages. Construction, the weather or some peril may hamper or halt your ability to operate. Are you insured for all of these things? You may be obligated to pay up when things happen. Where does the money come from?
7. No tested, cash flow management plan
Money goes in and money goes out. You just don’t know when or how much at any given time. There’s no tracking system to help you anticipate when those tough times may come, how to deal with irregular flows of revenue and unusual expenses, and help you determine whether you have the cash and coverage to pay for it all. Surplus situations can turn into ditches of business debt. That may impact your personal debt challenge.
Some investing and financing activities do not have any direct impact on cash flows. For example, conversion of debt to equity, acquisition of an enterprise by means of issuance of share, etc.
Improving your cash flow can really up give advantage for the company in the business industry. Most business owners see growth as the solution to a cash-flow problem. That’s why they often achieve their goal of growing the business only to find they have increased their cash-flow problems in the process. Plan for growth and the related cash outlays in advance, so they do not come as a surprise. Here are some of the things to reconsider in planning for business growth.
To speed up the receipt and processing of receivables. Spring for a lockbox service, post office boxes serviced by banks so that customers in far flung locations can mail payments there and the checks will be processed by the banks more quickly. Ask customers to pre-authorize checks so that banks can draw against their accounts at timed intervals. Centralize your banking at one bank. Ask customers to pay with depository transfer checks, a relatively cheap fund transfer. You can also try offering discounts to customers if they pay bills quickly.
Tightening credit requirements
Businesses often have to extend credit to customers, particularly when starting out or growing. But you have to do your research beforehand to determine the risk of extending credit to each customer. Can they pay their bills on time? Is their business growing or faltering? Are they having cash-flow problems? You should also check references. An option to extending store credit is to accept credit cards. This will cost you a percentage, generally from 2 to 5 percent of the sale, but it may be a safer bet for getting paid on time.
If you need more cash, it seems like a no brainier to go out and try to attract new customers or sell additional goods or services to your existing customers. But this may be easier said than done. New customer acquisition is essential to a growing business, but it can take time and money to convert prospects into sales. Selling more to existing customers is cheaper and you may be able to do this by analyzing what they’re buying and why – information that may even lead you to increase your profit margin and, hopefully, generate more cash. But be careful that the businesses when increasing sales because you may just increase your accounts receivables and not actual cash if these sales are on credit.
One option to increase cash flow is to offer your customers discounts if they pay early. While this practice may impact your profit margin, it may help your management of cash flow by incentivizing customers to make payments earlier than billing cycles typically require. Your company may also take advantage of this with suppliers and others that you owe, but be careful that your early payments of debt don’t leave you with a cash flow shortfall.
Short-term cash flow problems may sometimes necessitate a business taking out a loan from a financial institution. Some possible types are revolving credit lines or equity loans. Most of the time this type of borrowing accomplishes its goals, although during the financial crisis many banks were canceling credit lines and calling in loans. Another option is a long-term amortized loan which includes interest and principal until the loan is paid off.
Managing cash flow in an eCommerce business is critical to survival and growth. Having an accounting department dedicated to your company internally can be extremely expensive. Here at Fully Accountable, we would recommend outsourced accounting for your eCommerce company. This will allow you to immediately have an expert team at a fraction of the cost operating your accounting department.
You are already working with partners, team members and vendors remotely, why not also do so with the critical function of your accounting and finance department.
This department is the one that will successfully track and manage your cash flow. While you may be thinking that there is no room in the budget to hire an outsourced accountant, I would like to challenge you that this department will probably be one of the most profitable departments in your company.
Act today and get a dedicated team member truly managing your cash flow so that you can win at growing and scaling your eCommerce business.