Everything You Need to Know About Cash Flow
To grow your business.
Cash flow is the money that is moving (flowing) in and out of your business over a period of time, typically measured by month.
Although it does seem sometimes that cash flow only goes one way - out of the business - it does flow both ways.
Every entrepreneur I have ever met has, in one way or another, asked me the same question: “If I’m making all this profit, where is it?” It’s a classic dilemma: our accrual-based P&L shows that we are operating a robust business that drops thousands of dollars to the bottom line— but the bank account always seems to be empty.
We provide in-depth information and “how to” information for measuring and monitoring cash flow in the “Cash Flow Statement” and “Cash Cycle” segments of this page.
There's no getting around it. Businesses run on cash. When the cash goes, the business stops.
Measuring and predicting the cash flow for a business is vital. Entrepreneurs need to be acutely aware of how much cash is available, how long it will last, and what factors are accumulating or depleting the cash.
Even business owners and their CFOs or financial managers who know better than to "hope" for positive cash flow tend to believe that if a business is profitable, then the cash flow will be fine. They are unlikely to fare any better because the two concepts are fundamentally different: profitability is a simple comparison of revenue and expense; cash flow describes the sources and uses of cash, plus the movement of that cash over a period of time.
As a result, improving cash flow takes a deeper understanding of the business, some specific tools and constant vigilance.Learn more at Cash is not a Dirty Word:4 Keys to Better Cash Management.
The calculation is quick and painless. Start with accounts receivable from the balance sheet (the total dollar value owed to you by customers) and the past 12 months of sales from the income statement. Use this simple formula to find the average number of days it takes you to collect money from customers. This is called "days sales outstanding," or DSO.
That's half the story. Now look at how quickly you pay your bills. Start with the total amount of accounts payable (the total dollar value you owe to vendors) and the 12-month sales number from before. Using the formula below, you can easily find the number of days you take to pay your bills, which we call "days payables outstanding," or DPO.
Look into the future
If you can float your bills longer than your customers do (DPO is greater than DSO), cash will actually accumulate in your business. However, if your customers are dragging their feet (DSO is greater than DPO), cash is going out the door. The bigger the difference (DPO minus DSO), the faster the cash is flowing--in or out.
So how bad is it? The difference, or "float," is the number of days of sales (in cash) that are flowing in or out of your business each year. So a $1 million business with just one week of negative float will watch nearly $20,000 evaporate from its checking account. (The equation is: sales/365 X float.) Worse, this entire drop can happen in just one payables cycle.
Fortunately, there are two ways to put a cork in a negative cash flow: collect more quickly from customers or get better payment terms from vendors. Doing either can plug the gap. Doing both will keep your cash flowing for many vintages to come.And how to forecast cash flow!
The amazing thing is that every company has the power to both predict and avert sales-related cash flow problems. A few numbers from your balance sheet and income statement are all you need to be forewarned of an impending problem.
Read more and learn how to predict cash flow @ Cash Flow Forecasting ... Show me the money!
Nobody can control all the factors that impact cash, but you can measure and monitor most of them. You can react quickly. You can be decisive and focused.
There is no single problem quite like a lack of cash in a small business. It deserves your full attention. And ignoring it will not make the problem go away.
But with careful monitoring and ample action, most cash flow problems can be cured.
Let's take a deeper look at seven tools that will help you understand, plan and improve your cash flow.
Read about each of these aspects of cash flow @ Optimizing Cash Flow: 7 Steps to Less Stress and a Better Business
Why is avoiding a crunch so critical? Many of the reasons have to do with human nature. Employees, suppliers and customer are adept at detecting duress. People get nervous. In lieu of cash, rumors flow. So besides the obvious problems of missing critical payments (like rent or payroll), the problems quickly compound both inside and outside the business.
It hardly bears repeating, but “Cash is king.” Proper cash management will pay off not only in reducing your stress, but also in important operational metrics, like preferred pricing and terms, bigger discounts and improved profits. Develop your strategies for cash flow management and follow them rigorously. Use the right ratios and metrics to project cash from actual, reliable, data.
The key to preventing a cash crisis is to plan, implement, manage, and predict.
But what if you have a cash flow crisis?
It’s ok, at some point every business owner feels it. But you are probably gong to have to “push” your cash cycle.To learn more, read Business Cash Crisis? Push your Cash Conversion Cycle
What would you do if your company ran out of cash?
I'm not talking profits. You can be profitable on paper and still have nothing in the bank to pay bills.
The key to surviving is fast action.
Read more about each point @ Cash Flow Crisis: 4 Rules for Survival