Posted on December 2, 2019

Many small businesses struggle with one very important component daily – Cash Flow.

What is Cash Flow? What does that really mean? And why is it so important? On a basic level, it’s straightforward. Money flows into your business – payments from your customers – and money flows out of your business – payroll, expenses, etc.

If you have more coming in than going out, you have Positive Cash Flow. If you have more going out than coming in, that’s the opposite: Negative Cash Flow. Obviously, you’d rather have positive cash flow because it’s exactly what it sounds like – money in the bank. If it’s negative, you may be able to sustain that for a while, but eventually, your cash reserves will run out. Then you won’t be able to pay your employees, your landlord, your suppliers, etc.

But why does Cash Flow matter, some business owners may ask. Isn’t my Profit and Loss statement a measure of my cash? Not necessarily. To explain that, let’s understand the difference between cash and accrual accounting.

If you report on a Cash Basis, that means you count your income only when you have the money in your hand. So your Profit and Loss report won’t show any income from invoices that are as yet unpaid.

If you report on an Accrual Basis, that means you count your income as soon as you earn it, whether you have been paid or not. In that case, your Profit and Loss report will show money that is not in your bank yet. It’s still in your customer’s bank, so it’s not a part of your Cash Flow yet. (Technically, it’s still a part of theirs!)

Even if you report on Cash Basis, however, there is a caveat. Your Profit and Loss reports show only the income and the expenses. Any Balance Sheet activity will not be reflected there. So even if your P&L shows a healthy profit, you might not have that amount in your bank account.

For example, if you have made payments on a loan, the principal portion of that payment does not affect your P&L. Only the interest lives on the P&L. Another reduction of cash would be the Owner’s Draw. The money you take out of the account for yourself does not affect your P&L reports. So if you show a profit of $5000, but you drew out $4000 for yourself, your bank balance will differ from what you see on your P&L.

Now that we know the answer to, “What is Cash Flow?” we need to understand why we should care about it.

There are many reasons. First, when a business is in the Start-Up phase, there won’t be much cash coming in right away. A good business plan will allow for that. Study the industry to see what expenses you can expect before the sales start. Then project how much cash you’ll need to invest to get past that first sale. In the beginning, more money will be flowing out than in. Be prepared to meet expenses for several months before the cash starts piling up.

Once you are underway and cash is coming in, a Cash Flow Statement is very important to make sure you have what you need. You’ll have to meet payroll, pay rent, buy supplies. Is your business generating enough cash to cover those things? If you extend terms to your clients, you’ll have to project when you expect those invoices to be paid.

Cash Flow Projections will be helpful to determine how much you are going to have and when. If you sell something for $5000 with 30-day terms, you know that in about 30 days, $5000 will be coming into your bank account. If Payroll is $2000 per week, you know that much will come out of your bank account on a weekly basis. Your Trusted Advisor can help you set up projections to see whether enough cash is coming in to cover your expenses.

Another essential reason to monitor Cash Flow is growth. As your business grows, so do your expenses. Do you have enough cash to cover the added cost of more payroll, more inventory, more insurance, etc.? You’ll need to know your expected cash flow to make smart decisions about your business.

Now that you know what Cash Flow is, how do you make sure you have plenty of it? The best thing you can do is carefully control your source of cash in the bank, Accounts Receivable. InvoiceSherpa is the best management tool for handling invoicing, communication, and payment for your customers. An automated A/R system takes the pain out of getting your money out of their Cash Flow and into yours. Try it and watch Cash Flow improve!