woman in a small shop analyzing factors that affect cash flow
ComplianceLegalNovember 04, 2020

Managing your business's cash flow

Creating a reliable cash flow system is vital to the success of any business. Learn how you can maintain enough cash on hand to keep your business solvent and growing.

A healthy cash flow is an essential part of any successful business. Some business people claim that a healthy cash flow is even more important than your business's ability to deliver its goods or services,

That may be placing a bit too much importance on your cash flow, but consider this — if you fail to satisfy a customer and lose that customer's business, you can always work harder to please the next customer. But if you fail to have enough cash to pay your suppliers, creditors or your employees, you're out of business.

Maintaining a viable cash flow system relies on six important aspects:

  • Understanding cash flow is the first step in effectively managing your cash flow. There's more to it than just a fancy term for the movement of money into, and out of, your business checking account.
  • Analyzing your cash flow will help you spot some of the problem areas in the cash flow cycle of your business. As in any good analysis, you need to look individually at each of the important components that make up the cash flow cycle to determine if it's a problem area or not.
  • Developing a cash flow budget provides a good way of predicting your business's cash flow for the next month, six months or even the next year.

Tools to Use

Included among the Tools and Forms is a cash flow budget worksheet. The worksheet is an Excel template that can be used over and over again after you download it once.

The worksheet is set up to be used for projecting your cash flow for six months. We've formatted the worksheet and put in most of the cash inflow and outflow categories for you. All you have to do is put in your numbers and print it.

Once you've downloaded the worksheet, feel free to modify the worksheet to fit your own needs.

Improving your cash flow will, without a doubt, make your business more successful. Accelerating your cash inflows and delaying your cash outflows are key factors for improving and managing your cash flow. The cash flow budget is also a handy tool to use in the improvement and management of your cash flow.

Filling your cash flow gaps: from time to time, almost every business experiences the need for more cash than it has. If you find yourself in this position, you may have to borrow money to fill the gap.

Handling any cash surplus is just as important as the management of money into and out of your cash flow cycle. With the proper management of your cash flow, you might find yourself with a little extra cash, on which you can earn investment income.

Understanding How Cash Flow Works

In its simplest form, cash flow is the movement of money in and out of your business. It could be described as the process in which your business uses cash to generate goods or services for the sale to your customers, collects the cash from the sales and then completes this cycle all over again.

Keeping Inflows Flowing

Inflows are the movement of money into your cash flow. It's, understandably, the cash flow component every small business owners wants to grow. Inflows are most likely from the sale of your goods or services to your customers. If you extend credit to your customers and allow them to charge the sale of the goods or services to their account, then an inflow occurs as you collect on the customers' accounts. The proceeds from a bank loan also count as cash inflow.

Delaying Outflows as Long as Possible

Outflows are the movement of money out of your business. It's, also understandably, the cash flow component every small business owner wants to decrease. Outflows are generally the result of paying expenses. If your business involves reselling goods, then your largest outflow is most likely to be for the purchase of retail inventory. A manufacturing business's largest outflows will mostly likely be for the purchases of raw materials and other components needed for the manufacturing of the final product. Purchasing fixed assets, paying back loans and paying accounts payable are also cash outflows.

Why Managing Your Cash Flow Matters

As you likely already surmised, optimizing your cash flow is crucial because: 

  • Smart cash flow management is vital to the health of your business. Hopefully, each time through the cycle, a little more money is put back into the cash flow cycle than flows out.
  • Our case study illustrates what can happen to your business if you don't carefully monitor your cash flow, and take corrective action when necessary.
  • Your profit is not the same as your cash flow. It's possible to show a healthy profit at the end of the year, and yet face a significant money squeeze at various points during the year.

Ideal Cash Flow Management Illustrated

If you were able to do business in a perfect world, you'd probably like to have a cash inflow (a cash sale) occur every time you experience a cash outflow (pay an expense). But you know all too well that business takes place in the real world, and things just don't happen like that.

Instead, cash outflows and inflows occur at different times and never actually occur together. More often than not, cash inflows lag behind your cash outflows, leaving your business short of money. Think of this money shortage as your cash flow gap. The cash flow gap represents an excessive outflow of cash that may not be covered by a cash inflow for weeks, months or even years. (Don't worry—you're not a bad entrepreneur if your business isn't cash flow positive immediately.)

Managing your cash flow allows you to narrow or completely close your cash flow gap. It does this by examining the different items that affect the cash flow of your business. Examining your cash inflows and outflows, and looking at the different components that have a direct effect on your cash flow, allows you to answer the following questions:

  • How much cash does my business have?
  • How much cash does my business need to operate, and when is it needed?
  • Where does my business get and spend its cash?
  • How do my income and expenses affect the amount of cash I need to expand my business?

If you can answer these questions, you're managing your cash flow!

Case Study: The Cash Flow Gap

This example shows how easily a cash flow gap—a shortage of cash caused by the mismatching of cash outflows and cash inflows—can occur in a small business.

For example, John makes custom furniture for professional decorators and furniture retail shops. In addition to himself, John has two other employees. John pays himself and his employees every other week (bi-weekly). When a customer places an order for a piece of furniture, John receives a 10 percent down payment of the total sales price. The customer is then billed for the remainder of the sale after the furniture is completed and delivered.

The total sales price of a recently ordered dining room set is $10,000. The material needed for this job is priced at $2,500 and will come from one supplier. This supplier offers a 2 percent discount if John pays for the supplies within 10 days after receiving them. John always takes advantage of early payment discounts.

The following graphic, illustrating the cash flow effects of the sale from start to finish, will help you identify John's cash flow gap.

Breaking down the sale of the dining room set, and tracing it step-by-step through the cash flow, identifies John's cash flow gap. In John's case, a cash flow gap starts on day 13 and continues to grow, reaching $4,450 just prior to collecting the customer's account. Although this example has been simplified, it's typical of the cash flow gap that occurs in many small businesses.

The cash flow gap creates the need for effective cash flow management. Effective cash flow management can help reduce the amount of time between John's cash inflows and cash outflows. This in turn, will help reduce or close John's cash flow gaps.

Mike Enright
Operations Manager
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