Business analysts report that poor management is the main reason for business failure. Poor cash management is probably the reason most businesses do not work. Understanding the basic concepts of cash flow will help you plan for the unforeseen eventualities that nearly every business faces.
Difference between Cash and Cash Flow
Cash is ready money in the bank or in the business.
It is not inventory, it is not accounts receivable (what you are owed), and it is not property. These can potentially be converted to cash, but can’t be used to pay suppliers, rent, or employees.
Profit growth does not necessarily mean more cash on hand. Profit is the amount of money you expect to make over a given period of time. Cash is what you must have on hand to keep your business running. Over time, a company’s profits are of little value if they are not accompanied by positive net cash flow. You can’t spend profit; you can only spend cash.
Cash flow refers to the movement of cash into and out of a business. Watching the cash inflows and outflows is one of the most pressing management tasks for any business. The outflow of cash includes those checks you write each month to pay salaries, suppliers, and creditors. The inflow includes the cash you receive from customers, lenders, and investors.
There are two types of cash flow, namely: positive cash flow and negative cash flow. When cash inflow exceeds the outflow, a company has a positive cash flow. A positive cash flow is a good sign of financial health.
On the other hand negative Cash Flow happens when cash outflow exceeds the inflow. Reasons for negative cash flow include too much or obsolete inventory and poor collections on accounts receivable (what your customers owe you). If the company can’t borrow additional cash at this point, it may be in serious trouble.
Components of Cash Flow
A Cash Flow Statement shows the sources and uses of cash and is typically divided into three components:
- Financing Cash Flow
- Investing Cash Flow
- Operating Cash Flow
Financing Cash Flow is the cash to and from external sources, such as lenders, investors and shareholders. A new loan, the repayment of a loan, the issuance of stock, and the payment of dividend are some of the activities that would be included in this section of the cash flow statement.
Investing Cash Flow is generated internally from non-operating activities. This includes investments in plant and equipment or other fixed assets, nonrecurring gains or losses, or other sources and uses of cash outside of normal operations.
Operating Cash Flow: Operating cash flow, often referred to as working capital, is the cash flow generated from internal operations. It comes from sales of the product or service of your business, and because it is generated internally, it is under your control
How Do I Practice Good Cash Flow Management?
Good cash management is simple. It involves:
- Knowing when, where, and how your cash needs will occur
- Knowing the best sources for meeting additional cash needs
- Being prepared to meet these needs when they occur, by keeping good relationships with bankers and other creditors
Cash Flow Management
The starting point for good cash flow management is developing a cash flow projection, or estimate of how much money will flow through your business. Smart business owners know how to develop both short-term (weekly, monthly) cash flow projections to help them manage daily cash, and long-term (annual, 3-5 year) cash flow projections to help them develop the necessary capital strategy to meet their business needs. They also prepare and use historical cash flow statements to understand how they used money in the past.
Break Even Analysis
Break even analysis is a tool used to determine when a business will be able to cover all its expenses and begin to make a profit. For the startup business it is extremely important to know your startup costs, which provide you with the information you need to generate enough sales revenue to pay the ongoing expenses related to running your business.
A startup business owner must understand that $5,000 of product sales will not cover $5,000 in monthly overhead expenses. The cost of selling $5,000 in retail goods could easily be $3,000 at the wholesale price, so the $5,000 in sales revenue only provides $2,000 in gross profit available for overhead costs. The breakeven point is reached when revenue equals all business costs.
To calculate your breakeven point you will need to identify your fixed and variable costs. Fixed costs are expenses that do not vary with sales volume, such as rent or administrative salaries. These costs have to be paid regardless of sales and are often referred to as overhead costs. Variable costs vary directly with the sales volume, such as the costs of purchasing inventory, shipping, or manufacturing a product.
The formula for determining your breakeven point requires no more than simple arithmetic.
Prepared by Veneranda Sumila in addition from the internet