What is Cash Flow?
Simply put, Cash Flow is the money that is moving or flowing into or out of your business. If you look at your financial statements you, hopefully, will find a cash flow statement. If not we need to talk.
- Cash is coming in from your clients or your customers. The people or businesses that are buying your product or services.
- If you are a retail store, then cash is coming in generally at the time of purchase. Think about shopping at Wal-Mart; when you buy the stuff, they get the cash (check, debit or credit card) from you.
- If you are a landscaper and bill customers and they pay monthly, you receive actual cash through accounts receivable. In this case cash comes in once per month for each customer. You hope anyway.
- Cash is going out of your business as you pay for things. Think about cash flow going out for payroll, rent, office supplies, repairs, utilities, inventory and so forth.
- A smaller operation generally has little to no credit with suppliers. Then you probably pay pretty fast or immediately like the Wal-Mart example above. Cash goes out as goods, services come in or employees work.
- Once you have been in business for a while and establish credit with suppliers this could change. In effect you can buy things on account. This is similar to a credit card or credit account. You buy it now and pay later. Technically the cash is leaving the business when you pay the bill. A landscaper could have an account at the local hardware store. Then the cash wouldn’t leave until they paid the bill later in the month.
Cash flow then is a snapshot of your business checking accounts. If more cash flow comes into the account than is leaving the account, you are in a “positive cash flow” situation. Unfortunately, if more cash flow is leaving the business then you are in a “negative cash flow” situation. As some of you may already know, this is when things could take a turn for the worse.
If you don’t have reserves built up, then you will run out of cash. Working capital is a term used to define how much cash and other capital you have to work with. Perhaps, you have a large balance of cash already, or a line of credit or some other financing to help cover the cash flow short fall.
Why is Cash Flow so important?
The #1 reason businesses fail is because they run out of cash. Some businesses have product failures or bad timing in the market. Still if they had more cash, they could overcome these issues. This is why lack of cash or cash flow is the top reason businesses fail. It is pertinent for a business to develop a logical plan of action and keep their “cash flow plan” top of mind.
Cash Flow in different types of Businesses
As mentioned earlier, cash flow looks a little different if you are paying for things immediately versus buy now and pay later. This also goes for your sales.
Take a step back and think about business cycles and how they impact cash flow. Take a landscaper for example. They probably make a lot of money and in turn have a high “positive cash flow” in the late spring and summer. On the contrary, they could have a high “negative cash flow” in the winter. This is a perfect example of a seasonal business. It takes a dedicated “cash flow management plan” to survive the entire 12 months of the year. Basically, the business cycle goes up and down through the seasons. If you spend all your money or cash by August, then undoubtedly, you will need a different job over the holidays to survive.
Wal-Mart on the other hand seems to be busy every time I go into that store. Their cash flow is more predictable and steady. Sure they have holiday spending. Perhaps there are different times of the month that are busier than others. In general, the “cash flow plan” should be smoother than that of the landscaper.
Positive Net Income and Negative Cash Flow
You say, how is this even possible? Well it is, let me explain. Net Income, by definition, is all the revenues minus all the expenses. Let’s assume you are the established landscaper. You have just finished a month and billed all customers. You have just paid (cash flow out) all your expenses for that same month. In the accounting world, you have earned Revenue that month. You actually performed services, even though you have collected no cash for those services. You have incurred expenses to go along with those services. There is also rent, office supplies, payroll and so forth.
Take all the Revenue and Expenses associated with all the work you did in the month. Subtract the expenses from the revenue and you arrive at Net Income – or close to it. Let’s pretend it is positive. Add up all the cash collected and cash disbursed. You guessed it, subtract cash flow going out from that which is coming in and you get “net cash flow”. Assume some of the customers haven’t paid yet. Your “cash in” is less than your “cash out”. This example has created a positive net income but has a negative cash flow for the month.
Optimistically, you now understand what cash flow really is. Also understanding the importance of cash flow to your business. If you would like you can also see my post on 10 Tactics to Increase the Cash Flow in your Business. Recall, the lack thereof is the #1 reason for business failure. Cash flow is king and is also, essentially, the lifeblood of the business.
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