Photo by Vladimir Solomianyi

Let’s break down the day-to-day money aspect of running a business and lay the groundwork for your business’ financial health.

For anyone running a business or thinking about starting one, it’s important to build healthy money habits to make sure your finances are keeping up with your expenses. Focusing on just the bottom line like profits and valuations often leads to neglecting one crucial detail: Cash flow. 

Why is this important? Well, a U.S. Bank study found that 82% of failed businesses had to throw in the towel because of poor cash flow management.

So, what exactly is cash flow? 

Well, in simple terms, it’s all about the money coming in and going out of your business. It’s like the heartbeat of your company, showing how cash moves through your operations over time. It’s about balancing your funds to cover operational expenses, pay suppliers, and be able to invest in what you need to grow your business. The last thing you want is to have an underfunded check issued to a supplier that’s due to be cashed in, or not be able to pay a subscription to your e-commerce store because of an oversight. 

Let’s start with getting to know the three types of cash flow:

? Operational cash flow 

Covers your day-to-day activities, like sales, expenses, and paying your suppliers and staff. 

? Investing cash flow 

Deals with big moves, like buying new equipment or selling assets. 

? Financing cash flow 

Involves how you fund your business, whether it’s through loans, investments, or issuing stock.

Managing each of these effectively can ensure you have the funds you need when you need it. Check out the 7 tips for optimizing cash flow for small businesses. 

Wait, but what’s the difference between cash flow and profit?

Here’s where things get interesting. Cash flow isn’t the same as profit. While profit looks at the overall financial picture of your business, cash flow zooms in on the actual cash moving in and out. You can make a profit on paper but still struggle to pay your bills if you don’t manage your cash flow wisely.

To put it all into perspective, let’s look at how cash flow can affect your business IRL. 

Picture a retail store that sees a cash influx during holiday seasons but slower periods during the rest of the year. If the lean months don’t generate enough revenue to cover operational expenses like rent, utilities, and employee salaries, it would make sense to set aside some of the surpluses from holiday sales to cover these payables when they’re due.

And what if a manufacturing company wanted to invest in new machinery to ramp up production? Looking farther ahead and seeing the potential of long-term gains could make it more worth the investment, but shelling out a large amount to buy that piece of equipment could lead to a temporary cash squeeze. Budgeting wisely is key until the new machinery can generate a return on investment and turn a profit. Alternatively, setting aside money for the investment before buying the equipment can help mitigate potential money woes down the line. 

Let’s not forget about startups relying on investor funding to get off the ground. Startups need to watch their operational expenses like rent, salaries, and marketing costs to make sure they don’t run out of cash too quickly. Investors want to see that startups are handling their money responsibly and have a plan to become profitable. As startups grow, managing cash flow becomes even more crucial to support expansion plans and stay afloat in the long run. 

The state of your cash flow also has a huge impact on whether your company will sink or swim. Deloitte says that companies making positive free cash flow have an average return on invested capital (ROIC) of around 15.5%. Pretty impressive, right? On the flip side, those companies swimming in negative free cash flow, average an ROIC of just a measly 1.5%. That big difference shows us how important cash flow can be for a company’s success.

But don’t panic just yet. Here’s how you can get started managing your cash flow to a T.

? Get Lean with Your Budget

You’ve got to be smart about your spending. That’s where a minimum viable budget comes in handy. It’s like being on a tight budget during college – you’ve got to make every dollar count. Keep your expenses in check, even when business is booming, so you’re prepared for those inevitable rainy days. Think of it like managing your personal finances. You wouldn’t blow your entire paycheck on a shopping spree, right? Same goes for your business – keep it lean and mean!

?Don’t Mess with Your Credit

When you start avoiding your bills because money’s tight, that’s not a good sign for your business. Delayed payments can tank your credit score faster than you can say “cash flow crisis.” Keep your credit in good shape by paying your bills on time and avoiding those dreaded collection calls. Flip the tables around and imagine how you would feel if your favorite online store suddenly started delaying shipments because they couldn’t pay their suppliers on time. Not cool, right? Don’t let that be your business!

?Tame Your Inventory Beast

Your inventory might not seem like a big deal, but you better believe it can wreak havoc on your cash flow if you’re not careful. Think expired products, lost orders, and wasted employee hours. Keep your inventory in check to avoid unnecessary expenses and headaches. It’s like rummaging through your closet looking for that one shirt you know you bought but can’t find. That’s what happens when businesses don’t track their inventory properly – except way more expensive!

?Stash Some Cash for a Rainy Day

Life’s full of surprises, especially when it comes to business. That’s why it’s crucial to have some cash tucked away for emergencies. Whether it’s a slow month or ahem, a global pandemic, having cash reserves can be a lifesaver when times get tough. We’ve all had to dip into our savings to cover unexpected expenses like car repairs at some point. Same idea – but for your business!

?Find Yourself a Financial Wizard

Every business needs a financial guru in their corner. Someone who’s not just good with numbers, but proactive about spotting potential cash flow issues before they become full-blown crises. Your accountant is your business’s guardian angel – always watching over your finances and swooping in to save the day when things get hairy.
By understanding how cash moves through your business and keeping a close eye on it, you’ll be better equipped to make smart financial decisions, seize opportunities, and navigate the ups and downs of entrepreneurship. Need more guidance? Book a mentor session with Selfmade today! Not yet a member? Try Selfmade absolutely free for 7 days!