A crash course in accounting is required when starting a small business. Cash flow is one of the concepts that become increasingly important as your new business grows. Understanding the cash flow of your business and learning how to grow it is vital in attaining success.

Gaining mastery of cash flow management, on the other hand, might be difficult. You are unlikely to have an accounting staff to assist you early on in your new business. It’s also possible that you won’t have access to a professional accountant at all. There’s only you, some accounting software, and a wealth of information on the internet.

Even so, understanding the importance of cash flow will put you on the path to success.

Cash is the lifeblood of any business. You can make the most out of your limited resources by following cash flows through your company. You can also find areas to improve, allowing you to become more productive and profitable over time.

Cash Flow Definition and Impact

Fundamentally, the term “cash flow” is an excellent way to describe how money moves in and out of your company. Money moves in as you collect cash from customers for the payment of your sold service/product. The money then moves out as you use it to fuel other aspects of your business, such as paying your staff, purchasing raw materials, funding R&D, and covering all of the other costs associated with running it.

Your cash flow can either be:

• Positive Cash Flow—You have more money coming in than money being spent. Having a positive cash flow is ideal in any circumstances because it could grow your bank account at every end of the fiscal year.
• Negative cash flow—You spend more money than you get in. Having negative cash flow means you’re losing money. Thus, you’ll need to raise more money to keep your business running through investment and borrowing. You will, however, eventually run out of cash.

Difference Between Profit/Loss and Cash Flow

Profit and positive cash flow may appear to be synonymous since, after all, both terms refer to the amount of extra cash generated by your business over a specific period.

However, it’s rather usual for a company’s cash flow data to diverge from its profit figures. The divergence occurs because certain non-monetary elements that have no impact on cash flow are included in profit/loss.

A good illustration of this is depreciation expenses which affect your profit/loss. These, however, do not involve a monetary outflow. Depreciation (and other comparable examples, such as amortization) is an accounting event, not an actual expense.

If your company has a lot of expensive equipment that needs to be depreciated, the discrepancy between your cash flow figure and your profit/loss number could be significant.

Cash Flow Formula

Consider the connection between cash flow and profit/loss. Both track the same things, but profit/loss includes non-cash elements. Remove these variables from the equation to arrive at cash flow.

To calculate cash flow, you must first determine your profit or loss. Then you eliminate the non-cash factors. Consider the following equation as an illustration:

Free Cash Flow = Net Operating Profit After Taxes – Change in Working Capital – Capital Expenditure

Where,

Net Operating Profit After Taxes = Net Profit + Depreciation/Amortization/Other non-cash expenditures

Example: Netflix: Streaming for Money

Netflix is an excellent illustration of the distinction between profit and cash flow. The corporation frequently invests a considerable amount of money in fresh content creation. (New episodes of The Crown are not available for free.) The company plans to spend more than $2.5 billion per quarter on expanding its content library.

As a result, Netflix has many quarters where it makes a profit yet burns through cash. Netflix, for example, made $542 million in net profits in the fourth quarter of 2020. However, it spent $3.3 billion on content and ended up with a $284 million cash flow deficit after everything was said and done.

It made a profit but only had a small amount of actual cash earned.

6 Tips to Improve Your Cash Flow Management

It would help if you improved your cash flow understanding to grow your business. Having a good grasp of cash flow management is essential. You should also be able to assess and improve your cash flow over time.

With that in mind, here are six tips to improve your cash flow management:

1. Be Wary of Not Getting Paid

Receiving payments from customers/clients is the first step in the cash flow process. You may be concentrating on developing relationships as a startup. You may not feel like leveraging on demanding prompt payment.

You must, however, remain persistent. You can have a hard time getting clients to pay on time if they get into the habit of doing so. Make incentives for paying on time, such as late fines or early-pay discounts. Have delinquent account follow-up measures in place as well.

2. Keep emergency savings on hand.

An unforeseen incident can cause a massive monetary crisis when you’re on a tight budget. Make a contingency plan for these potential disasters. Build up significant financial emergency savings and try not to use them until you’re in a dire scenario.

3. Prioritize Cash Flow Over Profitability

Yes, becoming profitable and increasing that profit over time is your ultimate goal. Cash flow, however, is more critical to your company in the long run. You can’t pay your bills if you don’t have cash. If you’re short on cash, a paper profit won’t help you much. Hence, prioritize cash flow over your profitability.

4. Develop Funding Options

You might have to tap into your cash reserve to seize possibilities. Burning cash for a short time can help you fund a significant expansion. However, if you find yourself in a tight financial circumstance, you’ll want to have backup plans.

Prepare for the worst-case scenario. Consider products such as a line of credit, which can help you smooth out cash flow hiccups. In addition, having a solid relationship with potential lenders and investors might be a lifeline in a pinch.

5. Seek assistance

It can be challenging to master cash flow management. Get as much assistance as possible. Accounting software is an excellent place to start. Consider hiring a professional accountant and bookkeeper when you can afford it.

6. Track your cashflow with appropriate accounting software

It all comes down to having the appropriate knowledge when it comes to controlling your cash flow. It isn’t easy to keep track of all the specifics amid day-to-day activity.

Attaining this oversight can be simple with suitable accounting software. Choose a software provider that offers cash flow tracking. Clear and up to date data can assist you in determining how to gain insights into improving your company’s operations.

Run Your Business More Effectively by Understanding Cash Flow

Don’t be intimidated by the math involved in cash flow tracking. Any small business owner will be familiar with the general concept. You want to be able to receive more money than you send out. It’s a relatively straightforward process.

Gaining more understanding of the subject, on the other hand, will benefit you in the long run. Learn how to calculate cash flow, get guidance on how to increase it, and use powerful tools (such as accounting software and the suitable online business bank account) to make the most of your resources. You can put your startup on the road to success by learning how to analyze and improve your cash flow.