Cash flow management is one of the fundamental processes of running a business. A business with healthy cash flow can pay for all of its expenses on time and turn a profit. An unhealthy cash flow could result in debt, missed payments, and messy business management.
As cash is always moving in and out of your business, it can be tricky to properly manage your cash flow to ensure everything operates smoothly. This guide will break down the basics of cash flow management, including five steps you can take to effectively manage your cash flow.
What is Cash Flow Management?
Cash flow management is the process of monitoring the money coming into your business (accounts receivable), and comparing it to the money leaving your business (accounts payable).
Properly managed cash flow should provide you with a clear picture of how your business stands financially, and whether you’re able to generate a profit after paying your expenses. Ideally, you have more money coming in than money going out.
Cash flow management involves implementing a strict bookkeeping process. This means keeping clear records of all payments, bills, and bank statements from your sales. You also need to maintain clear records of all money going out, like vendor payments and payroll.
Why is Proper Cash Flow Management so Important?
Keeping a close eye on your revenue and expenses is a fundamental aspect of running a business. It helps you understand how efficiently your business is operating, and whether you might need to increase revenue or cut down on expenses.
Successful businesses also often have cash reserves to see them through possible rough patches. Keeping a close eye on your cash flow will help you understand just how much reserved cash you might need for a given time period, and how well you can control your business’s financial situation.
When performing cash flow management for your business, it’s important to understand the difference between profit and revenue.
- Revenue: Any money that comes directly into your business, such as cash from a sale.
- Profit: The money your business has left after paying its expenses. Profit = revenue – expenses.
How to Manage Cash Flow
You can effectively manage cash flow for your business in five steps.
1. Establish a Cash Flow Forecast
Start by making cash flow projections that you can realistically see your business achieving. This involves understanding how much revenue you’ll need to generate in order to turn a profit and making realistic revenue forecasts based on your business.
Various factors should be considered when forecasting your cash flow, such as seasonality, price increases, salary increases, and your specific trading environment.
2. Calculate Your Revenue
When you have an estimate of many sales you will make, you’ll need to figure out how much revenue this will bring into your business. When doing this, it’s important to also understand how long this revenue might take to enter your bank account, and when you actually have the cash available.
3. Calculate Your Expenses
Now, understand what your monthly expenses will look like. This will involve fixed expenses (like rent, insurance, and salaries), as well as expenses that change each month (like purchasing stock). Use your business’s previous expenses to help you forecast this.
4. Review Your Finances
Consistently review and update your financial projections based on your business activity. Business is rarely ever consistent, so it’s important to always stay up to date with what’s actually happening and apply this to your cash flow forecast.
5. Manage Your Financial Reporting
Once you have a solid system in place for forecasting your cash flow, you need to carefully manage your actual financial reports. It’s essential that you maintain up-to-date financial reports to help you understand the financial health of your business and make more informed decisions.
Make sure you always keep a close eye over your balance sheet, and that you understand any trends and irregularities in your profits and losses. The better you understand your business’s financial reports, the more efficiently you can run your business. Using the right bookkeeping software will help to make this process easier.
Carefully managing your cash flow will help you have cash on hand when you need it. It will also help you understand when you can pay your business expenses, and how best to manage these.
A key part of running a business involves actively forecasting your cash flow and preparing for this as much as possible. The better you can predict and plan your cash flow, the smoother your business will operate.
SEE ALSO: WHAT IS INCREMENTAL CASH FLOW?
