Cashflow is one of the most commonly misunderstood concepts in business and it’s vital to understand it correctly.
It is, of course, the measure of how much money is moving into and out of a business during any given time period.
Positive cash flow, that is cash flow where the money moving into a business is greater than the money moving out of the business, is a positive indication of a business’s liquidity, flexibility and their overall financial performance. This is because positive cash flow says that a business is increasing its liquid assets, which means it can cover its obligations, make investments in the business, pay a return to shareholders, cover expenses and weather any unforeseen financial challenges.
So, How Do You Manage Cashflow?
Many business owners find managing their cashflow a challenge but, in fact, it doesn’t have to be that complicated.
As an accounting professional, I use a simple process with my clients to help them ensure that their cashflow stays positive:
- Understand the cashflow requirements of the business – before you can manage cashflow, you have to know how much cashflow you need for your business to be healthy. That means examining what’s coming in and what’s going out.
- Having a funding plan for the first five years – new businesses are especially vulnerable to cashflow shocks. If you know how you will fund your business for the first five years, you can insulate your business from such shocks.
- Having a cashflow plan – no matter how long you’ve been in business, you need a cashflow plan to ensure you always have enough cash on hand to meet your obligations. Profitable, successful businesses can fail if they neglect their cashflow.
- Know your financials – your financials should be kept up to date and you should spend time with your accountant learning how to review and read your P&L (profit and loss) as well as your balance sheet. They’re your financials after all.
- Having a clear business budget in place – taking control of the line items in your business life means you become very aware of what’s going out and what’s coming in.
- Have a risk management plan – understanding your cashflow is one thing, knowing what could hurt you and planning to mitigate that risk is better. This may include the purchase of insurance, estate planning, business structuring and building better business processes.
- Consider using a cashflow management system – we use Profit First at Accounting Heart as it’s a simple, easy-to-implement process that really works.
And that’s it, when it comes to cashflow management – it might look a little overwhelming, but it isn’t. In fact, a few hours spent on getting this right when you start out in business will be one of the best investments you ever make in your business.
What Are The Most Common Errors In Cashflow Management?
Sadly, I get to see some real horror stories regarding cashflow and these are the biggest mistakes that I witness on a regular basis:
- Insufficient start-up capital – this is why you need that 5-year plan when you start out, it takes time (often more time that you might anticipate) for a business to get up and running and return the kind of income you had before you went into business.
- Poor tax and super management – this can be caused by a whole spectrum of issues. Some new business owners just don’t understand the obligations on them as a business owner and don’t invest in finding out. Also, dealing with tax and super obligations is often just not that much fun and thus, it gets neglected while the owner looks to generate sales and income.
- Business owners not managing their own pay correctly – you can’t just take money out of the metaphorical till to pay yourself as a business owner, well, you can but the taxman won’t like it and it will cost you a lot of money in the long run. You need to know how to take money out so that it won’t harm cashflow.
- Business owners that value lifestyle over the long-term – I’m not saying you shouldn’t buy a boat or a luxury car, I’m just saying that it shouldn’t come at the expense of not meeting your financial obligations to others as a business owner.
- No plan/poor financial management – you need to plan to deal with cashflow correctly and you need to understand your financials and your financial obligations to manage them effectively.
Final Thoughts On Cashflow
If you don’t already have the skills to manage your cashflow, you should sit down with your accountant or financial advisor and go through everything you need to know.
Then, you need to build plans to ensure that your cashflow always stays robust. You owe it to yourself and the long-term future of your business to do so.