Tracking and understanding cash flow is vital for any business. You need to know how the amount of money you bring into your business compares to the amount going out. If you're spending more than you're earning, you need to make changes to avoid going out of business.
"Put simply, cash flow is the money that will be coming in and going out of the 'register,'" said Ron Pac, financial planner at the Barnum Financial Group. "Managing cash flow means understanding upcoming expenses and comparing them against accounts receivable as well as projected future sales."
It's important to regularly track the movement of funds in and out of your organization to identify where your business is from a financial standpoint and where it will be in several months.
"Cash gives our business power – the power to hire the best talent, purchasing power for the goods and services we need to grow to take advantage of new opportunities that may arise," said Div Bhansali, vice president of marketing at AccountantsWorld.
Editor's note: Looking for information on accounting software for your business? Use the questionnaire below, and our vendor partners will contact you to provide you with the information and quotes you need:
Cash flow management terms
To help you better understand cash flow, here are a few key terms you'll want to be familiar with.
- Accounts payable: The money a business owes its suppliers.
- Accounts receivable: The money your customers owe.
- Terms of payment: The conditions of invoice payment, including the time given to pay and frequency of payment.
- Burn rate: The rate at which your business is consuming available cash. Bhansali said this is especially important for startups or businesses that are operating at a loss.
- Negative cash flow: The cash leaving your business is greater than incoming cash.
- Positive cash flow: The cash coming into your business is more than the money you're spending.
- Shortfall: A deficit of expected income or profits.
Projecting cash flow
Determining when you'll receive and need to spend money is part of the budgeting process. To successfully project cash flow, organizations can look at their prior year's numbers as a basis of cash flow for the following year. Then, adjust for anticipated changes, such as new pricing, more personnel and funding sources.
As the year unfolds, you should update your cash flow projections to accurately reflect developments in expenses and profits. Comparing budgeted cash flows to actual deposits and expenditures will help you predict cash flow later.
Another strategy is adding up cash you already have with the cash you plan to receive and when you plan to receive the cash. After you have that number, add up how much you plan to spend of that money.
Even the most successful organizations find their forecasts change on a regular basis. That's why it's important to regularly monitor your cash flow.
There is a wide selection of tools and software that make tracking your business's money easy. If you're not interested in taking the time to understand the software, you may want to work regularly with a professional accountant. To choose the right accounting software for your small business, read our buying guide.
Addressing shortages and maximizing surpluses
For many small businesses, staying on top of cash flow management is hard. In the event of a cash flow deficit, companies have a number of options for until deposits start to come in. Here are six solutions:
- Apply for a loan from a banking institution or individual.
- Apply for a line of credit from a bank institution.
- Speed up the collection process.
- Finance the purchase of equipment through leasing or loans.
- Liquidate assets.
- Delay payments to vendors.
You won't always find yourself with negative cash flow. Sometimes, you may have a surplus of cash. That money can affect future opportunities, so you don't want it to sit around.
Accountants recommend that you make the money work for you. You can do this by making short-term investments and using the money to pay off debts faster. This way, the money will manifest its use through generated interest or shorter loan terms.