Do You Know How Important Cash Management Is?

Understanding the basics of cash management is extremely important when running a small company. In fact, business analysts call poor money management one of the leading causes of business failure. If company owners learn to plan for unexpected expenses and effectively manage streams of incoming and outgoing cash, they can be well on the road to entrepreneurial success.

Differences Between Cash Flow and Cash

Cash flow is not the same thing as cash. The term “cash flow” refers to the cash that is moving in and out of a company. It’s crucial to watch both incoming and outgoing money streams in order to keep track of a business’s financial position. Checks that are written each month in order to pay creditors, bills, and employee salaries are all considered outflow. Inflow is the money received from investors and customers.

Cash includes the readily available funds in the company’s bank accounts and/or petty cash funds. It doesn’t include accounts receivable, inventory, or business property, because although these noncash items can be converted into liquid funds, they can’t be used to pay bills or payroll.

Businesspersons sometimes confuse profit with cash on hand, but the two are not the same. Profit is money that is projected to be generated over a specific period of time, and cash is the liquidity needed to keep the company up and running. Profits cannot be spent.

Cash Flow Statements

On a statement, cash flow is divided up into the following parts.

• Operating: Operating cash flow is also called working capital; this is the money that comes from internal operations, such as from the sales of a business’s products and services. Because this money is created internally, company owners have control over it.

• Financing: Financing cash flow includes funds that are made via external sources, such as investors, shareholders, and lenders. Also in this category are stock issuances, loan repayments, and new loans.

• Investing: Investing cash flow is derived from nonoperating internal sources. Some examples of this type of cash flow include nonrecurring losses and gains, investments in the physical plant, new equipment, and additional fixed assets.

Proper Cash Flow Management Tactics

In order to properly manage cash flow, a business owner needs to practice certain tactics, such as knowing how, when, and where cash will be required; being acquainted with additional cash sources when needs arise; and maintaining good relationships with creditors and banking professionals. In order to effectively manage their cash flow, entrepreneurs and company owners should develop long- and short-term cash flow projections, so they can meet capital requirements to fund their businesses. Short-term plans should include weekly and monthly strategies. Long-term projections should encompass annual and three-year to five-year plans.

Improved Cash Management

Cash management can be improved if specific areas are focused on, including inventory, accounts receivable, and accounts payable. It’s important to have a solid credit policy in place to screen customers, which would include checking credit worthiness before extending credit and following up on late payments in a timely manner. For accounts payable, it is preferable to pay suppliers on time, but not early. Moderating the amount of money used for inventories can also create better cash management.

For a business to be profitable, it has to manage cash flow by generating more revenue than expenses. Striking a balance between having too much liquidity and too little will play a big part in the success of a company. Having enough cash available to act on opportunities as they arise is important, as is having money in investments to generate interest income.

Bottom Line

The bottom line regarding cash management is that to create a healthy financial position, a business must manage income and outgo of its money effectively. A company needs to generate funds from its practices and put enough away to meet future goals and needs.

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