In the beginning stages of a business, cash is often the most important factor for ensuring success. It is vital, therefore, for businesses to predict and control cash properly.
Most businesses begin to manage cash by constructing cash flow statements and other forecasting tools. Cash flow is a measurement of the amount of cash flowing into and out of a business during a specific time period, such as a week or a month. At the end of the designated time period, if a business has received more cash than it has spent, it will have a positive cash flow. By analyzing its projected cash flow statements and its actual cash flow statements, a business can devise ways of maximizing cash flow. A projected cash flow will serve as a major budgeting tool because it will give you an idea of your cash needs well in advance.
Cash flow should not be confused with sales or profits; it is not uncommon for a small company to make a significant sale or be operating profitably and still go broke because of insufficient cash flow. This can happen, for example, when the company doesn’t get paid for several months after its product has been delivered. In the meantime, the company may run out of cash when trying to pay current expenses. If you price your product too low and have high expenses, you may also run out of cash.
How does cash flow into and out of a business?
Sources of cash
Most businesses start with an initial cash investment made by its owners. As the business makes sales, it generates cash as well. If a business needs more cash, it can look to bank loans or additional investments by the owners or others (equity or debt financing).
Uses of cash
Businesses use cash in a number of ways. Capital expenditures are made when a business uses its cash to invest in its own buildings, equipment, and other fixed assets. Cash is also used to repay debt to those who’ve lent money to the business, and to pay salaries or dividends to business owners. Additionally, of course, cash is used to pay current expenses (e.g., utilities, employee wages, and other periodic bills) and to acquire current assets (e.g., office supplies).
How do you construct a cash flow statement?
The statement is divided into four major sections–starting cash, cash in, cash out, and ending cash–which should be listed on the left side of the document. Across the top of the document, you should list appropriate time periods (e.g., January, February). A typical cash flow for a small company is laid out to cover a year. Therefore, you need to be able to estimate sales and periodic inflows of cash, as well as projected outflows of cash.
You list your starting cash balance (as of a particular date) at the top of the document. Your cash in section should be subdivided into sections, such as:
- Cash sales
- Collected receivables
Likewise, your cash out section should be subdivided into several categories, such as:
- Office supplies
- Accounts payable
- Debt repayment
Obviously, the more specific you can be, the more helpful the cash flow statement will be. At the bottom of the cash in section, include a line for total cash in. At the bottom of the cash out section, include a line for total cash out.
Next, subtract your total cash out from your total cash in. If the result is a positive number, you have a positive cash flow for the month. If the result is a negative number, you’ll need to analyze the statement to see where you can cut back. The final number on your statement will be the ending cash. This consists of your starting cash plus your cash flow figure.
How can you analyze a cash flow statement to maximize cash flow?
A cash flow statement can help you to maximize your cash flow by uncovering certain cash-related problems. Because it can also help you to project the amount of cash your business will have coming in and going out on a monthly basis, it can also help you to determine how much money you may need to borrow from a bank or obtain from investors. You can maximize your cash flow by effectively managing the outflows and inflows of cash.
Manage the outflow of cash
You can decrease the outflow of cash by cutting back on some of your expenses. For instance, you can move to cheaper offices to cut back on rent, reduce the hours of your employees to lower the expense of wages, examine telephone bills and office supplies carefully, and cut back on owners’ salary withdrawals. In addition, you can consider leasing expensive assets instead of purchasing them outright.
You can also push for more favorable credit terms with creditors. For instance, if you currently have to pay your accounts payable in 30 days, you might renegotiate so that payments can be made in 60 or 90 days. In general, you can minimize your financing costs by accelerating your income from customers while slowing your payments to creditors.
Manage the inflow of cash
You can increase the inflow of cash by tightening credit policies with your customers and aggressively collecting receivables. Try giving small cash discounts to customers who pay their bills in a timely fashion. Also, think about wire-transfer payments to speed up receipt of payment. You can also try to keep your inventory as low as possible, seek up-front payments, increase prices, and step up sales efforts.