What You Need to Know About Cash Flow
February 14, 2019
In business, there’s an old saying that goes “cash is king.” Assuming that this is true, cash flow is the heartbeat of a successful business. Even if your profit margins look healthy, if you don’t have positive cash flow, your business is doomed to failure. Here are some fundamentals that every business owner should know about cash flow.
What is cash flow?
Cash flow is the money that is flowing into and out of a business. In order to have positive cash flow, you need more money coming in than going out. When a company runs out of liquid assets, it is on very shaky ground. Many companies that show good profit margins end up going bankrupt because of poor cash flow management.
Why is positive cash flow important?
Positive cash flow means that a company’s liquid assets are increasing. This enables the business to pay expenses, improve business operations and survive any downturns in the market. Even if a company has good profit margins, it could quickly get into serious trouble if cash flow is tied up in accounts receivable or inventory.
It might be tempting to spend more on inventory when profits are high, but if this leads to negative cash flow, one bump in the road could send the company into bankruptcy. This is why investors and creditors need to know cash flow data about any companies that they’re dealing with.
What is free cash flow?
Free cash flow is defined as operating cash flow minus capital expenditures and dividends. Analysts need to look at free cash flow (FCF) in order to get a sense of the true profitability of a business. This actually tells an even better story than net income because FCF shows how much money is available to expand the business or pay off debts and liabilities.
Managing cash flow
In order to achieve positive cash flow, you need to follow several steps. It takes careful management and analysis to manage the inflow and outflow of cash. Use cash flow analysis to be sure that there is enough inflow of cash each month to handle all costs and obligations of the following month. Many accounting software platforms are designed to help manage this process. You can even use tools that are available on websites if you don’t want to invest in software.
Although cash flow is the lifeblood of a business, many business owners lack a full grasp of how to properly understand and manage it. Studies have shown that poor cash flow management is one of the most common causes of business failure. Make sure you understand the importance of cash flow management and take thorough steps to plan and monitor cash flow as a regular part of your business operations.