An important part of owning and operating a small business is understanding the concept of cash flow. Small business owners can be entrapped into misinterpreting cash flow as profit, which is incorrect. Cash flow is the cash you have available at any given time to pay bills and other expense. This includes cash generated from sales, loan payments, and capital expenditures.
For a small business, effective management of cash flow is vital to stabilize your business and keep it running smoothly. If you have ineffective cash flow management you may not have an accurate idea of your available cash and assets and can make a critical mistake regarding your expenditures. Here are three basic methods to managing cash flow:
1) Calculate Your Cash Flow Cycle – A cash flow cycle is the number of days it takes your business to produce a product, sell the product, and receive payment for the product. Once you know how many days it takes a product to proceed through this lifespan, you divide 365 by the sum total of days per cycle in order to calculate how many cash flow cycles your business has in a given year. The fewer the number of days in your cycle, the more cash your business will have on hand.
2) Calculate Cash Generated Per Cycle – Once you know how many days are in your cash flow cycle you can calculate how much cash each cycle generates. Account for the expenses required to produce your product against the cash you receive from a sale. If the cash you generate exceeds your expenses per cycle than you have positive cash flow. You can then increase this cash flow by generating more cash per cycle or reduce the length of a cycle to generate more cycles per year.
3) Generate Sales! It can become easy for a small business owner to be caught up in managing their cash flow. If you focus on tweaking your cash flow constantly and using resources trying to make minor increases to your cycles, you can wind up diminishing your sales. Do not fall into the trap of using your resources that should be generating more sales on cash flow management; sales are the life blood of your business, never lose sight of the big picture.
Understanding the mechanics and concepts behind your cash flow cycles is of vital importance to a small business. By reducing the number of days per cycle you can dramatically increase the cash you have on hand at any given point, giving your business’ assets much needed flexibility during the course of a year. Cash flow management skills are a must for the success of your small business.