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BFS Capital Blog

What is Business Cash Flow?

December 8, 2016

Business math is funny. Somehow you have $100,000 in sales during a month, and still bounce a check to your electrician. Profits are good and business is doing well. So why does your bank account still look like you’re a 19-year-old college student?
It’s All About Cash Flow for Your Business

Cash flow and profits are not the same thing, and this is a huge misconception small business owners make. Cash flow is simply the amount of spendable currency you have coming into your business in a given period, more than the money going out. Sounds simple enough, but many business owners still don’t seem to grasp the concept. That’s because accounting for profit and loss statements is different from accounting for cash flow. Many seem to confuse the two.

Understanding and effectively managing cash flow is one of the most important parts of a successful small business. Positive cash flow means you can do things like hire more staff, spend on marketing and advertising, and even pay yourself a salary. But when cash flow is negative, you end up having to expend energy and resources finding financing to pay the bills, and your business never grows.

Many small businesses, because of huge cash startup costs, have their initial cash spent on assets. This, in accounting terms, can be expensed through depreciation. But depreciation doesn’t pay your electric bill. So while the balance sheets might look good, the cash flow needs to be positive for you to be successful.
It’s Not Your Income, It’s the Cash in Your Account

Cash flow is different than income because it concerns the cash you have on hand rather than the money your company has earned. Here’s an example:

Say you own an industrial soap company. Your checking account has $50,000 in it, and this month you’ve sold $50,000 worth of soap on a net 60 basis. So if it’s January 1, you won’t get paid until March 2. That means, no cash is coming in.

Meanwhile you’ve spent $5,000 on rent, $10,000 on payroll, and another $10,000 on inventory. That’s $25,000 going out, and $0 coming in.

Although your income for the month is $50,000, your bank account is now down to $25,000 due to cash flow restrictions resulting from your customers’ net 60 payment terms.

To further exacerbate the issue, on February 1st, let’s say you have an unexpected, massive equipment repair to make, which costs $20,000. Because it’s February 1st and you have $25,000 in your account with no additional cash coming in until March 2nd, this repair will be hard to make, especially considering you still must pay rent, your employees, and to cover your deliveries. So even though you’ve made $50,000 in sales, you have no cash on hand. And with over $45,000 going out and nothing coming in until you make another sale, factoring in the net 60 wait time, you’re going to be scrambling for financing. Even though, on the books, your company is profitable.

Theoretically, in March you’ll get a windfall of $50,000 from your January sales, but what happens if people pay late? Or you have more large expenses? Or you need to buy more chemicals to fill the big orders you’ve gotten, which won’t result in cash for another 60 days?

This is how a profitable company goes broke. It all comes down to cash flow management for your small business.
How Do I Manage Cash Flow?

You need to anticipate an average monthly cash income before budgeting for cash expenses. Your cash income would be any accounts receivable coming in that month, as well as cash interest payments, investment dividends, cash from sales of assets, or pretty much any other time you got a check, wire transfer, direct deposit, or actual cash.

Credit card sales are also considered cash in, since banks pay you that money and collect from customers. Credit (allowing a customer to pay you over time) is NOT cash in, unless the customer pays some of that money owed during the period.

Then you figure your cash out. This would be any payments you make on assets, rent, payroll, utilities, inventory, raw materials, taxes, loan interest, or any other time you write someone a check. Purchases made on credit cards do not count. However credit card payments do. New loans do not count, but payments made on loans do. You may also want to calculate those payments based on your expected cash in.

The goal is to have positive cash flow every month. Is this always possible? Of course not, but if you don’t at least aim to balance your books, you never will. It’s fine to have negative cash flow as long as you have some cash reserved. Make a habit of it and you’ll be closing your doors very quickly.
How Can I Improve Cash Flow?

Adjusting for cash flow isn’t as simple as adjusting for negative income. Sure, cutting costs and increasing sales would be one factor, but again, if those sales don’t bring in money for 60 days, or those cost cuts won’t show up until the end of the quarter, your cash flow problem will persist.

First, consider shortening the amount of time you give customers to pay. If giving them time is resulting in a lack of cash on hand, it’s time to shorten that leash.

Also, set a cash flow budget every month in addition to your normal one. Follow the steps above and make every effort you can to fall within that budget.

Think about creative ways to make large purchases that stretch the cash outlay over a longer period. This CAN be financing, but it can also be finding investors, taking out short term business loans, or putting things on credit cards.

Finally, think about how much inventory you need on hand at a time. If you only need a month’s worth of stock or raw materials, only keep that on hand. The more you must spend to replace it, the bigger dent that puts in your cash flow.

There are all sorts of ways to manage cash flow, and every business will have different requirements for how to keep it positive. And if you need an extra cash infusion to keep yourself afloat, BFS Capital has many funding solutions for you, from business loans to merchant cash advances.