According to a report by the US Bank, approximately 82% of businesses across all sectors fail due to poor cash flow management or a poor understanding of what a proper cash flow entails. This statistic alone should illustrate the importance of understanding cash flows and what they mean for your business.
In this article, we will take a look at the definition and importance of cash flows in order to give your online business the best possible chance for success.
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What is Cash Flow?
What is cash flow in simple terms? Cash flow can be defined as the relationship between the money coming into your business and the money going out. This differs from profit, as you can make a high amount of profit while still having poor cash flow.
A positive cash flow is when more profit is made than expenses to the business. A negative cash flow is quite the opposite; this is when your expenses are more than what your business is making. A business that has a negative cash flow is unsustainable long-term and is, therefore, more likely to fail.
Why is Cash Flow Important for Your Business?
Cash flow is extremely important to manage in order to ensure the success of your business. Prioritizing having a positive cash flow at all times enables you to easily meet your existing financial obligations as well as plan for the future.
Cash flow forecasts are also a crucial step in planning your future finances. A cash flow forecast is a prediction of your business’s financial state at a given point in the future, for example, 12 months from today’s date. If you are spending a total of $500 every month on business expenses, and your monthly income is $2000, then it stands to reason that you will have made a profit of $18 000 in one year. This is a positive cash flow statement, and your business’s cash flow forecast is also positive.
However, your cash flow forecast is not ideal if you are spending $500 and your monthly income is $800. This is where you look at your expenses, decide what can be eliminated, and try to find ways to get more cash flowing into your business.
Staying on top of your cash flow can also be useful when looking to grow your business. It can help you to determine when you will be financially stable enough to expand and plan accordingly.
You can calculate cash flow using the cash flow formula below:
The Types of Cash Flow
Three types of cash flow cover the three main activities in your business: operating activities, investment activities, and financing activities.
Operating activities cover all of your regular, day-to-day business activities. Inflows include revenue made from sales, interest and any dividends you receive. Outflows include operational expenses like software subscriptions and marketing.
Investment activities refer to income gained or lost through all of your short- and long-term investments. For example, money made through the sale of assets would count as inflows, and payments for the purchase of assets are outflows.
Financing activities refer to the money raised from debt or debt owed to others. For example, inflows might be money you’ve borrowed, and outflows can be the repayment of debts.
4 Common Cash Flow Challenges and Solutions
Challenge 1️⃣: Seasonality & Fluctuating Revenue
Businesses that experience seasonality or fluctuating revenue streams at certain times may struggle to maintain a consistent cash flow throughout the year.
- Develop a detailed cash flow forecast that accounts for any seasonal fluctuations.
- Implement strategies to diversify revenue streams, such as offering additional products or services during off-peak seasons.
- Establish a line of credit or access to short-term financing to cover cash flow gaps during slower periods.
- Plan for cash reserves during peak seasons to help sustain operations during lean periods.
Challenge 2️⃣: Late Payments & Bad Debts
Delays in receiving payments from clients or dealing with bad debts (debts that are not deemed recoverable and will not be paid back) can strain your business’s cash flow, especially in trying financial times.
- Set clear payment terms and enforce them consistently.
- Offer incentives for early payments, such as discounts or rewards.
- Implement a credit control system, including credit checks and limits for clients where possible.
- Establish a collection process for outstanding invoices, and consider working with a collection agency if necessary.
Challenge 3️⃣: Inefficient Expense Management
Poor management of your business’s expenses can deplete any cash reserves and hinder cash flow.
- Conduct a thorough review of your expenses and identify areas where costs can be reduced or eliminated.
- Negotiate with suppliers for better payment terms or discounts.
- Implement cost-control measures, such as tracking and analyzing expenses regularly.
- Use technology solutions for expense management, such as automated systems or cloud-based software.
Challenge 4️⃣: Lack of Contingency Planning
Unexpected expenses or emergencies can have a significant impact on cash flow if businesses are unprepared for them.
- Create a contingency plan that includes a cash reserve specifically allocated for unforeseen circumstances.
- Regularly review and update the contingency plan to adapt to changing business conditions.
- Purchase appropriate insurance coverage to mitigate financial risks.
How to Improve Your Cash Flow
The only way to improve your cash flow is by ensuring that your inflows are always greater than your outflows. There are several ways to do this, such as:
✅ Send Invoices Promptly: To prevent clients from paying late, you can send out your invoices as soon as possible after the completion of your work. You can also include a clause in your contract that enforces a fee for late payments.
✅ Reduce Your Expenses: Take a look at your outflows and determine whether or not some expenses can be eliminated. For example, you may be able to cut a subscription to a tool that you rarely use.
✅ Increase Your Fees: If you feel as if your expenses cannot be cut, then you may need to increase your rates to avoid a negative cash flow.
✅ Increase Sales and Marketing Efforts: One way to increase your inflows is by increasing your sales and marketing efforts in order to acquire more clients. You can do this with cold calling techniques, paid advertising, or a variety of other strategies.
✅ Monitor and Forecast Cash Flow: Regularly monitor your cash flow and create forecasts to anticipate potential shortfalls. This will allow you to take proactive measures and make informed decisions to improve your cash flow.
✅ Use Tools: Certain tools, such as QuickBooks, Xero or Freshbooks, can help to improve your business’s cash flow. As well as providing you with the capabilities to track, analyze, and optimize your cash flow, this tool can help you to easily stay on top of your finances for better financial decision-making and improved business performance.
Monitoring your cash flow is critical to managing a successful online business. A positive cash flow is essential for meeting financial obligations, planning for the future, and pursuing growth opportunities.
By understanding and managing your cash flow effectively, you can ensure the stability and longevity of your business. By prioritizing cash flow management and implementing healthy financial practices, you can steer your business toward financial success and minimize the risk of failure due to poor cash flow management.