Cash flow describes the movement of cash in and out of your business. This statement in your balance sheets shows how much money comes into your business as earnings, and what comes out as expenses. Having a solid understanding of your cash flow gives you a better picture of your business’ health. It also makes sure that you file taxes correctly and avoid problems with the Internal Revenue Service.
If you want to achieve a financial turnaround for your business, you must understand how cash flow impacts it. You could also, by extension, know how to effectively manage your cash flow and improve your financial health with this crucial knowledge.
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Understanding Profits and Losses
Any discussion on cash flow is complete without touching profits and losses. Profit is simply a term used for financial gain. It means that the company earned revenues that exceed its expenses. Theoretically, a profit could mean that the company has excess cash. The company can either the money put into its reserves, payout as dividends to stockholders, or acquire new equipment and additional commercial properties.
Loss, on the other hand, is the opposite of profit. It means the company’s expenses have exceeded its revenues for the period. Some entrepreneurs automatically interpret a loss as financial trouble, but that is not always the case.
Profit and loss could also be referred to as positive and negative cash flows. These mean various things for a business.
What Does Positive and Negative Cash Flow Mean?
Positive cash flows are a sign that your business model is succeeding in capturing a share of your market. It also indicates that your audience positively accepted your service or product. Sustained positive cash flow signals an opportunity for growth. Entrepreneurs should leverage this flow to reinvest in new assets or introduce a new offering to the market.
Negative cash flows show that there is not enough cash flowing into your business to sustain your operational expenses and your existing obligations. They could mean poor income. However, businesses that have invested in growth also experience periods of negative cash flow. These businesses likely earn the same revenues before the growth but also saw a growth in operational expenses from the expansion.
What Are the Effects of Cash Flow on Your Enterprise?
Positive and negative cash flows impact several aspects of your business. For example, having a negative cash flow also adversely affects your business’ spending power. If you don’t have enough revenues generated to support your expenses, you will have to draw from your cash reserves. Unfortunately, drawing from your cash reserves is not always beneficial.
A common remedy to negative cash flow is financing. Lenders will give you the money that you need to turn your cash flow around from negative to positive. It’s a very effective tool, but also requires careful consideration. Accumulating too many debts could as well tip the balance over to the negative side. At that point, your business will be in serious trouble.
Negative cash flows could also impact your business credit score. A cash flow that is too deep into the negative side could mean the business has defaulted on one or more debts. Your scores will plummet when these are reported to the business credit bureaus. You’ll find it difficult to secure financing for your cash flow, and this is a time that you’ll need it the most.
Positive cash flow, on the other hand, keeps your business healthy and sustainable. It has enough cash from its revenues to pay off or maintain operating expenses like employee salaries and benefits, utility bills, equipment maintenance, and debt repayments. It also keeps investors confident and happy in your enterprise.
Tips for Effective Cash Flow Management
Effective cash flow management requires careful study of your financial statements to find accounts that you could optimize and turn your cash flow positive. Here are a few tips that you could consider if you want to keep much of the cash coming in from exiting the business:
- Invest in accounting software
Accounting software is a great investment. Its most immediate impact is to automate accounting-related processes like invoicing, collecting, and generating reports. It also helps you cut back on expenses on wages and staff benefits.
- Create a more effective collection policy
Outstanding invoices are only assets on paper. The only time they’ll be of real value to your business is when they are liquidated or turned into cash. This is a good time to reformulate your collection policies. Alternatively, you could also approach factor companies to help you collect on those invoices. You could also advance cash against these receipts from the factors.
- Renegotiate supply agreements
Go over your supply agreements with your partner vendors and renegotiate with those that you think have become too expensive. Most vendors will be more than happy to renegotiate terms and retain your business. This is also a good time to look for better deals from other suppliers so you have alternative options if your partners refuse to discuss new terms.
- Liquidate any non-performing assets
Assets are designed to bring in income for you or to assist in revenue generation processes. Assets that are no longer helping to generate income will need to be liquidated. This will bring in additional cash that you can put into your reserves or inject back into your cash flow.
- Schedule cash flow meetings
Cash flow management is not a band-aid solution. It requires regular updates to keep your cash flow positive. As an entrepreneur, you will need to schedule regular cash flow meetings with your accounting team to keep yourself on top of the situation. Meetings can be as sparse as once a month, or once every quarter.
The Bottom Line
Effective cash flow management is synonymous with positive cash flow and good financial health. It is your responsibility as an entrepreneur to stay on top of your finances. That’s why you must understand what cash flow is and how it impacts your business. An accurate perception of how money flows through your business will let you spot problems early and act on them.
It is a good idea to sit down with your accountants once a week, or twice a month, to analyze your financial statements. Be sure to apply context when analyzing your cash flow. As mentioned above, a negative cash flow isn’t always a sign of trouble or poor financial health. It could also be a result of growth and should be remedied as such by increasing marketing budgets to raise your revenues.
Maintaining positive cash flow is vital to keep the business healthy. It requires a lot of discipline. However, it also promises success and growth as indispensable returns on your investment in time and effort.