Cash Flow: The Lifeblood of Your Company
Cash flow is nothing more than the movement of money in and out of your business, just like the flow of blood through the body. Cash is in continuous circulation through the “arteries” of the business, carrying value to its “organs”. If the flow is stopped or severely reduced, then serious consequences result.
Cash is not the same as profit. Your business may be profitable, but at the same time face a serious cash flow problem, for example in the case of a rapidly growing business. So, it is not wise to focus exclusively on your bottom line and forget your money supply.
It’s not difficult to understand that you may have already or are about to have a cash problem. Danger signs include:
- Bank account balances drop below normal average
- Inventory is building up.
- Bills are being paid late
- Banks are asking for financial statements
- And so on
But when you see these signs, it might be too late. If you use QuickBooks as accounting software, you can find two useful cash flow reports: Statement of Cash Flow and Cash Flow Forecast. They are filled in automatically by the software, you just need to press a button (of course is you have QuickBooks on your PC and you keep it current). By using these tools you can predict what your cash flow will be two or three months ahead, or even six months, and act accordingly.
What are the causes of a poor cash flow? The main flow of cash into the reservoir comes from “accounts receivables”, while the main cash out-flows are payments in “accounts payable” and payments of salaries and wages, and operating expenses. Obviously, if sales are falling, more cash is flowing out than the one coming in. When this happens, if your business has enough “working capital”, you can gain the time necessary to find solutions, such as increasing sales through intense marketing and reducing costs. So, the working capital is your reserve. Looking at the balance sheet, working capital is current assets (almost liquid assets) minus current liabilities.
There are ways to calculate exactly how much working capital a business needs. This is done taking into consideration the sales volume and the sales cycle, that is the time which is elapsing since receiving the goods, shipping them, paying the vendors and finally receiving payments from the clients.
Working Capital is very important. And way too often I see businesses that are failing because they did not have enough capital when they started.
In the next blog I will list different ways to replenish a company’s working capital, or how to give a blood transfusion to your business. And, of course, how to stop the bleeding, otherwise a blood transfusion is useless.
