No matter what type of business you run, cash flow is vitally important.
It's critical to know the status of your cash flow in order to understand the liabilities your company can afford and to assess the overall financial health of your business. Having cash readily on hand at any given time provides flexible, meaningful buying power, but it could lead to a false sense of security without a comprehensive familiarity with how cash moves in and out of your business.
Why is cash flow so important?
Your cash inflow is the amount of money funneling into your business. This is typically the result of purchases (non-pending) of products or services by customers, money contributed by investors, and interest on savings. Tracking your positive cash flow on a day-to-day, month-to-month and year-to-year basis allows business owners to better assess what investments they can make to grow the business – whether that’s increasing inventory or hiring new employees.
Contrarily, cash outflow includes all the money leaving the business. This includes rent on facilities, wages for employees, purchases of inventory, buying office equipment, and the like.
Clearly, maintaining a positive net cash flow (inflow less smaller outflow), and preferably a significant positive cash flow, is the holy grail. A consistent, positive cash flow should give you the confidence you need to make critical purchasing decisions without the worry of putting them off because you’re unsure you can make the money next month to justify an immediate loss.
Keys to maintaining a healthy cash flow:
- Keep constant and accurate track of your inflows and outflows on at least a month-to-month basis: As obvious as this might seem, having the numbers in front of you on a consistent basis will give you increased flexibility to make complex financial maneuvers when needed. Having only a general idea of your monthly cash flows could make a mistimed investment costly or leave you with less cash than expected in the long run.
- Be aware of consistent fluctuations: Many businesses are affected by seasonal cycles of business. Knowing exactly what cash flow you can expect in peak and valley months will give you a better understanding of how healthy your business is, especially as it relates to competitors’ performance.
- Encourage prompt or upfront payments: Immediate knowledge of the inflow of cash is a beautiful thing, and cuts the risk of obtaining the money in return for a product or service. Setting incentives for customers to pay quickly to get cash in the door, or adjusting payments for a long-term project into smaller pieces, will help you keep a more consistent and stable cash inflow.