April 22, 2022
Every small business owner needs to understand the importance of cash flow and how it impacts your business. At the end of the day, the survival of your business depends on cash, so making sure you are simultaneously tracking profitability and cash flow is crucial.
Cash flow represents the net amount of cash and equivalents that enters (inflows) and exits (outflows) a business over time. It differs from profit as it is measured on an accrual basis. For example, if you purchase a new property, this expense takes a one-time cash outflow, but under accrual standards, this expense could be amortized over many years. Thus, cash illustrates the financial health of your business by showing the excess cash it has on hand for expenses, unexpected circumstances, and potential capital expenditures.
For whatever reason that your business starts to face turbulent waters, you need to be prepared for uncertain times and unplanned expenses. If you suddenly need to repair a critical piece of equipment or face a temporary closure, you’ll need the funds to carry you through those difficult times. For this reason, it’s incredibly important for you to prepare in advance. By ensuring that you always have an emergency cash balance on hand, you will prevent any situations where your business completely runs out of cash for its operations. Instead, you’ll always have a steady amount that will be reliable during any emergency situation.
Another important aspect of cash flow management is accounts payable and receivable. When businesses offer customers the opportunity to pay in credit, this method often increases sales and customer satisfaction. However, it’s also important to consider the financial implications of this as well. When you make sales on credit, you may recognize the revenue from the sale, but the cash from that sale may only be accessible a few weeks in the future. Therefore, this gap could cause issues if you are struggling to pay off your expenses when you haven’t received payments from customers.
When it comes to short-term planning, the most important metric is the cash that you have on hand. For example, if you’re looking to make a significant expenditure, the most important metric will be the cash that you have available. You won’t be able to make that investment, even if it’s highly profitable if you won’t have the cash to sustain your operations in the following weeks. For this reason, your cash flow forecast provides the best insight into whether you will have the cash currently, and in the coming months, to make investments.
Other short-term operations are also focused on cash flow. Short-term budgeting allows you to plan when and where to spend money, but your budget will ultimately come down to the amount of excess cash that you have forecasted. Therefore, the cash flow forecast provides a key baseline to plan your short-term operations – whether you will have the cash to sustain your plans.
The first step in creating a cash flow forecast is to determine the time period for the forecast. Your decision will largely depend on the goals of your forecast, as well as the amount of prior data to help you create your forecast. The further ahead you forecast, the more uncertainty there will be, so long-term forecasts will certainly be more useful and accurate for businesses with an established history and predictable cash flow patterns.
After you’ve established a time period for your forecast, the next step is to collect historical data for income and expenses. Look at your past journal entries, bank reconciliations, and other documents to find patterns in prior years’ cash flow. When does your business typically have the largest cash expenditures? What are the biggest expenditures? Are there any recurring expenses that can be reliably predicted? Once you have these accounted for, you can then start to predict the cash flow for future months.
Accountero integrates with forecasting tools to predict your cash flows. With built-in calculators and assessment engines, founders can forecast revenue, calculate cash burn and predict their runway all within the Accountero platform. Furthermore, clients get on-demand access to financial modelling experts for help with complex or nuanced calculations as required by certain niche business verticals.
Accountero helps startups and growth-focused businesses with their finances. Accountero is a ‘built for founders’ financial platform that offers digital bookkeeping on a free tech-stack, high-level reports for business owners, forecasting tools and on-demand access to professionals like fractional CFOs, tax advisors, funding experts and more, who can help with tax planning but also with SR&ED rebates and other grants. Talk to us today so we can help you to stay focused on your business growth, while our experts manage the finances.
Accountero is a tech-powered service provider offering bookkeeping, tax advisory and fractional CFO. Accountero is not a public accounting firm and does not offer services that require a public accounting practice license.