Cash flow is a vitally important concept for any business owner, yet many entrepreneurs don’t take it into consideration when assessing the health of their businesses – what is cash flow and how does it affect your business?
Cash Flow Defined
Before we discuss the importance of cash flow, it’s important to know what the term really means. Every business receives money in the form of revenue from sales (cash inflow), and must spend money on staff, premises, raw materials, products, and many other costs (cash outflow).
The difference between cash inflow and cash outflow is the actual cash flow of the business. This is similar to the difference between what an individual earns each month and what he or she spends.
Cash Flow: A Confusing Term
Because cash flow is calculated by subtracting expenses from revenue, it makes sense that a positive cash flow is good for every business. The cash on hand once expenses have been covered can be used to pay overheads or invest in new stock or product development. Without a positive cash flow, a business will not be able to pay its bills on time without resorting to debt.
The word cash flow has been known to cause confusion, especially for entrepreneurs who don’t have a background in finance. For example, many new business owners confuse cash inflow (the revenue the business receives from sales) with cash flow. The fact that your business is receiving healthy revenue is excellent, but only if its expenses are controlled – many businesses run at a loss despite having a healthy turnover.
The Importance of Cash Flow in Your Business
As a business owner, cash flow is the life blood of your enterprise. Without a positive cash flow, you will be unable to pay bills, salaries, and invest in new business activities without borrowing money from your bank or other credit providers. A positive cash flow also allows business owners to draw equity from their businesses from time to time in the form of dividends – without a healthy cash flow you won’t reap the rewards of your hard work as an entrepreneur.
Having Too Much Cash Flow is Also Possible
When it comes to cash flow, it is certainly possible to have too much of a good thing. If your cash flow is too high, it could mean that your business is keeping too much cash on its books – this indicates that you should use some of this surplus cash flow to generate a profit and not allow it to stagnate in your bank account.
Since a business is intended to make profits and provide a return on investment that is higher than money on deposit, striking a balance between having too much and too little cash flow is vital for all entrepreneurs. If you’d like to know more about cash flow management, your financial advisor will work with you to optimise the use of cash in your business.