When starting a dream business, aspiring entrepreneurs often don’t know the basics of cash flow management. Therefore it’s essential to learn some simple guidelines for managing cash flow from operating activities that will help you run your business more consistently and efficiently.
Lack of free cash flow can cause many problems for a financial manager. This can provoke business growth stalls and even ruin it if you don’t have the necessary resources to keep it afloat. But with a clear understanding of your operating cash flow, you can plan and manage your financial needs.
Driven by passion and excitement, many small business owners start their dream business and dive into it without fully understanding what to do when it comes to cash inflows and outflows.
By following a few simple guidelines for managing your cash flow, you can improve the resilience and performance of your business. You will also be able to adapt to unexpected spending, reinvest capital to spur company growth and increase your chances of getting financing from lenders.
How to manage cash flow?
Cash flow is:
- The money that goes into your business
- Initial bank balances any small cash
- Interest earned on bank balances and investments
- Loans or lines of credit
- Investments from venture capitalists
However, sales are the most important part of your cash flow. If you don’t have customers that are willing to buy your product or service your business will not survive.
It’s essential to remember that your cash flow is very different from your profit.
Profit is what you have left at the end of the month or year after covering all your business expenses, and your cash flow is the money that you have at your disposal at a certain point in time in order to settle with counterparties on time and maintain a good reputation for your business.
So, here are three simple steps to help you manage your cash flow:
Step 1: Calculate the cash conversion cycle
The cash conversion cycle is calculated by the amount of time needed to purchase consumables, provide a service or manufacture a product, or sell your product/service, and receive payment from a customer.
Basically, the cash flow cycle is determined by the time required to generate cash from your core operating activities. If you have a short cash convert cycle, this means you can quickly profit from your business.
The shorter your cash conversion cycle, the more money you have at your fingertips to pay expenses, pay off accounts payable, and start over. If you have frequent cash conversion cycles, your business is technically more efficient because you can quickly profit from your core business.
Step 2. Try to increase the amount of money you generate in 1 cycle
If your money is not tied by investment or settlement, then the sales revenue allows you to generate positive cash flow in every business cycle. To generate more cash per cycle, you can try to increase your sales or lower operating costs (such as salaries), if possible, for each cycle. Or you can try speeding up the process to generate more cash flow cycles per year.
Step 3: Make sure your operational business process brings you additional time and resources
No one can run a business with the same awareness, conviction, and passion that a business owner does. If you spend all your time generating more money through financial and investment activities, you might be missing out on increasing sales, promoting or advertising your business, building network sales, and access to online communities that allow you to attract customers and potentially generate additional income.
Therefore, if possible, prioritize cash flows from operating activities and related activities.
Why is it important to manage your cash flow efficiently?
Proper cash flow management can keep your business afloat and help you manage other essential operations, including:
- Management of unforeseen expenses. For a small business, day-to-day operations are often unpredictable and resources tend to be limited. You can easily plan for expected fixed costs such as rent or utilities, supplies, and salaries, but losing a repeat order from a major customer or suddenly breaking critical equipment can throw your business out of balance.
- Business management. When your business isn’t progressing as planned, it feels like you’re plunging into chaos. Smart cash-flow management gives you more control over your business, helps you see its prospects, and makes important decisions in order to change the undesirable course of events in time, introduce innovations, launch new products or services, or enter new markets.
- Debt financing. Bankers, lenders, and investors typically analyze cash flow related to operating activities to make investment decisions and finance your operations.
- Expansion funding and business growth. A positive cash flow from operating activities also allows you to reinvest and expand, increasing your bottom line and your customer base.
Cash flow is an essential component of the financial health of your business. The more liquid your cash flow is, the more adequately you will be able to respond to the ups and downs of your business.