Written by: Marlene Piche, SVP Head of Branch Banking, Union Savings Bank
Small business cash flow management seems pretty self-explanatory, right? It’s just keeping track of cash inflow and outflow. In theory, it is simple, but a study has found that 82 percent of businesses fail due to poor cash management. This mismanagement, in part, is caused by several misconceptions about small business cash flow.
Proper cash flow management is essential to the survival of any business, but especially to small businesses. We’ve put together a list of the top five misconceptions about small business cash flow management and debunked each one to shine a little light on the truth about cash flow management.
Misconception #1: “I have strong profits, so I must have positive cash flow.”
While it’s great that you have strong profits, profits don’t directly correlate to cash flow. Profits are the funds left over after you’ve paid your expenses. It’s the difference between what you charge your customers and how much it costs to run your business. Cash flow, on the other hand, is the amount of money being transferred into and out of your business. This includes the money your customers pay you and the money you pay to cover your business expenses.
Cash flow indicates the money you have now, so a positive cash flow signifies an increase in liquid assets. This does not always align with profit. Say, for example, your business had a strong month of sales, so the profit increased from the prior month, which had weaker sales. This is great, but you’ve got bills to pay now and those funds won’t go through accounts receivables for 30 days. In this scenario, your profits increased, but you would actually have negative cash flow.
Cash flow can also contradict profit when a business uses an accrual system of accounting. In this case, the accrued accounting shows expenses and revenue for which the actual cash may not have been exchanged yet. This means that while there will be a profit shown, there will be no actual cash to show for it.
Misconception #2: Our accounts receivable is strong, so we don’t have to worry about cash flow.
Much like having strong profits, having strong accounts receivables is great, but it does not directly relate to small business cash flow management. Accounts receivables, or invoices, are promises from customers to pay at a future date. They are not cash, so they are not part of your business’s cash flow.
Misconception #3: “We generate cash flow statements every month. That’s enough.”
Generating a small business cash flow statement is a good first step, but it’s not the same as managing your cash flow and it’s not enough. A cash flow statement simply records how much cash has moved in and out of the business in the past. You need to put a cash flow management system in place to generate monthly cash projections in addition to the cash flow statements.
A cash flow projection, or cash flow forecast, will show you if you need to take out a loan, how much money you’ll need to borrow and when and how you will be able to repay the loan. It also helps you anticipate the ups and downs of your business’s cash flow and plan accordingly.
Misconception #4: “We generate cash flow projections every year when we do our budget. That’s enough.”
This is a very common, but slightly startling misconception. Just like you wouldn’t wait an entire year to check your bank account, you should not wait a year to generate cash flow projections. Yearly cash flow projections are too broad to keep you in the know when it comes to your cash flow. A lot can happen and change in a year, and you need to be able to adapt to unexpected situations quickly and efficiently with the confidence that you have the funds to do so.
By preparing monthly cash flow projections, you will be better equipped to handle unforeseen obstacles and have a better understanding of where your business stands at any given moment. This is especially helpful when tax season comes around, a time when you will probably see a significant difference in your cash flow. If you’ve been doing monthly projections, you are more likely to be prepared.
Misconception #5: “My business isn’t big enough to need cash flow projections/cash flow management is too complex for small businesses.”
Regardless of the size of your business, you need to generate monthly cash flow statements and projections. Smaller businesses with less funds need to maintain strict cash flow control as they have less of a buffer to absorb unexpected costs or other financial obstacles.
In order to effectively control your cash flow, you have to actively manage it. While small business cash flow management may seem very basic from the outset, there are many variables involved – too many to try to keep track of in your head. Once you lose track of them, they can quickly become unmanageable. Luckily, accounting software is available to help you with your small business cash flow management.
Cash flow management is a critical concept and skill for businesses of all sizes. Your business’s cash flow determines how well and how long you can operate and can be used to attract loans and investors. For these reasons, it is paramount that business owners take the time to gain an in-depth understanding of proper cash flow management and the steps involved in it.
If you’re looking for more information about small business cash flow management, book an appointment to talk to your business banking expert to discuss best practices for your business.
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