and Why is it so Important
For new business owners, the answer to their question, “What is cash flow and why is it so important?” is summarized in this article. The short answer is cash flow is the amount of money coming in to a business and the amount of money going out. Think of it as a water tank: water comes in at the top and drains out the bottom. So, to keep your tank full, you need enough coming in to cover what is going out.
Cash inflow is the lifeblood of a business and it can come from several revenue sources, or investments and loans. Cash is extremely important because it pays for things that make the business run, such as, wages, inventory, subcontractors, rent and all other operating expenses. Having a positive cash flow means that your business can run smoothly, and a higher positive cash flow will allow the business to make new investments (hire employees, open another location), and further grow the business. Positive cash flow is mostly driven by two things: organization and planning. Conversely, negative cash flow is generally a lack of planning, or the business is not performing well.
Starting up - When starting up a new business, there are many one-time start-up expenses that have to be paid, including: incorporation fees, legal and accounting, licenses and permits, construction or remodeling, security deposit on a rental agreement, or purchasing property, marketing materials and signage, initial inventory or supplies, fixtures like cash registers, office supplies, furniture, equipment, etc.
Budgeting - Once these costs have been paid, it is important to develop a budget to determine the monthly expected cash sources, cost of sales and operating expenses. These can be projected sales, loans that are known to be coming in at a certain date, investments from partners, or investments. As a suggestion, the projected sales forecast should be done on a conservative basis - it is always better to outperform and have a higher inflow of cash than expected.
If the business has been in operation for a while then there is a distinct advantage in projecting revenue and expenses. However, history can’t predict the future, but it can paint a decent picture of what the future looks like and what business changes are required.
Finally, all of the monthly expenses need to be estimated and accounted for in the budget. Monthly expenses to factor in can include rent or mortgage, insurance, advertising, marketing, website hosting, travel, utilities, payroll, inventory, taxes, loan payments, working capital, and last but not least, the owner’s compensation. Careful thought should be given to any changes or exceptional things that may occur in the business so they are not overlooked.
Once the budgets are in place, the next step is to start planning for cash to ensure the business always has sufficient available cash to meet its debts and obligations. The starting point is to look at the available cash in the business bank account and any unused lines of credit, as well as available credit card limits, if they are to be used. Then, usually on a monthly basis, try to estimate when cash will be received and when it will be paid out. This will show the business’s monthly net cash flows, either positive or negative, and will affect the available bank balance each month in order to show any deficiencies or concerns.