The Importance of Managing Cash Flows
Managing Cash Flows – Why is It Important for Your (Small) Business?
You have a great business; one that you know has the potential to earn big. You have a good business strategy, a great business location, great products or services; in fact, everything is just…well, great. You start out your business that, albeit still small, you know will eventually grow big one day.
Everything is just going along fine as you embark on the road of business and entrepreurship. And then suddenly you wake up one day to the reality: your business is floundering! You’re unable to pay your suppliers, your employees’ salaries, and your loans. You’re not even able to pay yourself!
You ask yourself what went wrong. You’re a great people person, you manage your time and your business well, you are so in to your business idea that it is just not possible that you are suddenly suffering illiquidity or insolvency or even bankruptcy. The answer? You were not able to plot and implement a good system of cash flow management. In short, you forgot to manage your cash flow well.
A good system of managing one’s cash flows or cash flow management can spell the difference between a successful business and a failed one. This is true whether the business is big or small. In any business venture, cash is always the king.
Cash is King!
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But My Business is Profitable, Why Should I Bother With Managing My Cash Flows?
First of, a profitable business does not mean a cash – rich business. You can be profitable but your cash flows are always in the negative. Why? Because there is what accountants would call ‘timing difference’.
Timing difference, in relation to profits and cash flows, is basically the difference between the date when you sold an item and the date when you collected the proceeds from selling that item (your cash inflows). Timing difference exists if you offer credit terms to your customers (like 30 days, 60 days or even 90 days).
In relation to expenses and cash flows, timing difference is the difference between the date when you actually purchased the item or when you availed of the services and the date when you paid for those item or services (your cash outflows). This, in turn, means credit was extended to you by your suppliers.
So what does the above mean? It means that you can see lots of sales on your profit and loss statement (the statement which tells you how profitable your business is) but you haven’t really collected all of them. It also means you can see lots of expenses on the same statement but you haven’t really paid for all of them.
So where does managing cash flows enter into the scenario (and believe me, it’s a common one)? Managing your cash flows will ensure that you will pay everything on time every time even when you don’t collect everything all the time. Bit of a tongue twister there, eh?
In short, even if your cash inflows or collections are not good, you are still able to pay off all your suppliers, employees, expenses and your debts. In other words, properly managing your cash flows will ensure that you will avoid illiquidity and, even, bankruptcy.
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Okay, I Hear Yah! Tell Me More!
Take it easy! I’m getting there.
First stop, you need to remember that proper management of cash flows does not mean that you have lots of cash on hand (or in your bank accounts) at all times. It means that even if you don’t have lots of cash today, you will get enough tomorrow to pay off everything that is due (or that you owe).
Secondly, managing your cash flows does not mean you ensure that all your cash inflows will come from your operations or sales. You can also get cash inflows from other sources like your investments and, even, your bank (through a bank loan). So make sure you have a good relationship with a bank, you’ll never know. You might run to them for a bank loan when you see you are about to face a problem paying off your suppliers.
Thirdly, learning to manage your cash flows will not happen overnight. It is not something that you can just snap your fingers at and then you will magically know how to manage your cash flows. And no, you don’t have to take a business or accounting course to know how to manage your cash flows. What you need to know is where your cash is really coming from and when will you get it and where your cash is really going to and when will you release (or disburse) it. To do these, you have to study and to observe your business and the movement of your cash. Sounds easy? Heck, no.
So How Do I Manage My Cash Flows?
Glad you asked. Here are some steps on how you can go about managing your cash flows:
1) Understand Your Cash Flows
Understanding your cash flows means you have a good grasp of your cash inflows and outflows and their movements. Where are your cash inflows coming from? When do you receive them? Where are your cash outflows going to? When will you release them? Understanding your cash flows is not an easy process as it sounds. You need to observe, and to record everything (and these things take time) so that you can have something you can study on.
2) Document All of It
Managing your cash flows is not something you can do all in your head. You need to put them all down into writing. If your business is small and you’re the only one handling everything, take heart. This portion is easier than it sounds. Just prepare an Excel file, record all your cash outflows and your cash inflows, by month and date. Group them according to their sources, then combine them. Do this every month of every year you are in business and soon, you will get solid information of your cash flows that you can use to analyze.
3) Analyze Your Cash Flows
You have a basic understanding of your cash flows. You know where and when your cash inflows and inflows occur. Now you need to analyze this information. Are your cash inflows often enough to pay for your cash outflows? Are you giving your customers more credit terms than what your suppliers are giving to you? If yes, is this fact hurting your cash flows?
4) Prepare a Working Cash Flow Budget
After you have documented and analyzed everything, you need to prepare your very own cash flow budget. This is basically a projection of all your cash inflows and outflows for the coming months or even coming years. You don’t need to be a fortune teller to do this one; you just need to have a realistic grasp of your current cash flow movement and an intelligent projection of your future cash flows.
5) Improve Your Cash Flows
If you have more cash inflows than outflows. Congratulations. That’s a sign that you’re managing your cash flows well. But if it’s the other way around, try harder! Either way, you still need to analyze your cash flows to see if there’s anything you can improve on it. Are you lagging behind in your collections? Are some of your customers not paying you on time? Accelerating your collections can help in improving your cash inflows. Are you paying your suppliers on time? Are you taking advantage of your suppliers’ discounts or do you get slapped with interest because your payment was delayed? Are you always hiding from the people your business owe money from (hope not!)? Improving your cash flows may be as easy as fast tracking your collections and may be as complex (and painful) as cutting down on your expenses, letting go of some people and even cutting down on your operations.
6) Handle Any Remaining Cash Well
Okay, you’ve done everything. You’ve managed to improve your cash flows and you are now managing your cash flows well. In fact, you always find yourself with excess cash. What’s left? Proper cash flow management means you also properly handle your excess cash well. Don’t leave it inside your cash vault. Invest it and earn more from it.
Hope you find this hub helpful. Good luck!
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Managing Cash Flows
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