“Managing the Cash Flow of My Business: Learn,” Starting and Growing My Business for Self-Reliance (2017)
“Managing the Cash Flow of My Business: Learn”
Learn
Maximum Time: 60 Minutes
1. The Difference between Profit and Cash Flow
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You have learned that business success requires daily record keeping. Every time your business receives or makes a payment, you need to record it. You have also learned how to create an income statement, which shows a summary of the profit (or loss) achieved by your business over a specific period of time. Profit is defined as the money left over for your business after you subtract your expenses from your revenue.
While profit is an important metric, it’s not the only one that demands your attention as a business owner. Cash flow is a metric that focuses on the timing of the movement of money in and out of your business every day. Cash flow is the lifeblood of your business. When your business has cash available, you can pursue options for growth, make investments, and save money for unexpected situations or emergencies.
Your income statement might show that your business is profitable, but it will go bankrupt if it doesn’t have enough cash to pay its obligations. Cash flow problems are one of the leading causes of business failure.
2. Understanding Cash Flow
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There are two types of cash flow:
Positive cash flow occurs when the total amount of cash coming into your business during a specific period of time is greater than the total amount of cash leaving your business during that same time. This is what you want: a positive cash flow cycle.
Negative cash flow occurs when the total amount of cash leaving your business during a specific period of time is greater than the amount of cash coming into your business during that same time. This is a risky, undesirable situation that you should address immediately with actions that generate cash as quickly as possible and reduce costs.
Let’s review three different examples to understand cash flow pressures and how a business owner might address them. Imagine that a business starts the month with 300 in cash. The business usually receives cash payments of 200 every Monday and 200 every Wednesday. It pays out 300 in cash every Friday. Example A below shows the cash flow cycle for this business over a period of three weeks. Money comes into and flows out of the business in a predictable pattern.
Example A: Ideal cash flow
Unfortunately, every business experiences surprises and setbacks. Example B below shows what happens when a business isn’t prepared for a negative cash flow. In this case, two customers don’t pay their bills, resulting in 400 of uncollected receivables (also called bad debt). The business owner was depending on this money to pay employees. The business also incurs an emergency expense that has to be paid immediately.
Example B: Negative cash flow—unprepared
Example C below shows the same surprises and setbacks as example B. But in this case, the business owner is prepared. She relies on her line of credit to keep her business operating. She repays the balance on her line of credit as soon as possible.
Example C: Potential negative cash flow—prepared
Discuss:
What do these examples teach you about the challenges of managing cash flow?
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It’s common for business owners to have cash flow challenges. Some of these challenges include:
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The newness of the business, which makes it difficult to receive and pay on credit.
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Growth opportunities, which can reduce the amount of available cash.
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Having inventory, which ties up cash.
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Customers paying on credit, which delays the amount of incoming cash.
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Selling to other businesses that pay on credit, which delays the amount of incoming cash.
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Uneven sales due to seasonality or other factors, which can create peaks and valleys in the amount of cash you have.
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Unexpected expenses.
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Nonpayment by customers (bad debt).
Discuss:
What potential challenges do you anticipate with the cash flow of your business?
3. Strategies for Improving Cash Flow
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There are many things you can do to create a positive cash flow cycle for your business and to prepare for possible surprises and setbacks. For example, you could research the standard payment terms for your industry. In some industries, vendors can wait 90 days or longer before they are required to issue payment. Other industries often require payment within 30 days. When you understand the standard payment terms for your industry, you can then work to negotiate more favorable terms for your own business.
Discuss:
Business owners generally want to receive or collect cash as quickly as possible and withhold paying cash until they are required to do so. On the surface, this principle may seem to conflict with the Savior’s teaching that “whatsoever ye would that men should do to you, do ye even so to them” (Matthew 7:12). As a business owner, how do you reconcile these principles?
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As you work to create a positive cash flow cycle for your business, it’s important to operate with integrity. Put in the effort to understand the payment terms for your industry. Be smart in setting up your payment strategy. Work to create favorable payment terms for your business. Once you have set your payment strategy, clearly communicate your expectations and keep all of your commitments.
4. Actively Managing My Cash Flow
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It’s not enough to periodically check your business bank account and hope that the numbers work out. You need to actively manage the cash flow of your business.
As a successful business owner, you should know how much cash your business has available at any time. Don’t rely on bank statements to manage your cash flow. Your account balance often doesn’t reflect payments that are in process, such as payments going out to suppliers or coming in from customers.
You need to create and continually update your cash flow projections. As explained earlier, cash flow is the timing and amount of cash that flows in and out of your business during a specific period of time. Your projection should show your expected cash flow for the next few months. Your projection won’t be 100 percent accurate, but it’s essential that you consistently establish conservative estimates for your monthly revenue, variable expenses, and fixed expenses.
Positive cash flow doesn’t just happen for a business. It’s achieved through hard work and careful planning. If you know your current cash position and future cash flow projection, you can make decisions that will help your business succeed and grow. Successful business owners keep a cash reserve for unexpected expenses and often line up sources of credit based on their projected cash flow needs.