Cash flow is the lifeblood of your business. Primarily, it comes from customers or clients buying your products or services, but can also come from loans, investor capital, or interest accrued on savings and investments. But cash isn’t just there to make your bank account look more respectable; it’s a crucial component in the growth of your business. You need cash on hand to buy stock or raw materials, pay and hire employees, and cover rent and other operating expenses.Cash flow is a natural barometer for a business. If you generate a positive cash flow, it means your business is running smoothly and you are positioned to further invest in and grow your business. Sustained negative cash flow means you are living on borrowed time.
Profits vs cash flowMany businesses fail because they confuse the profits on their balance sheet with cash coming into the business. Read our blog on, The Five Most Common Causes of Business Cash Flow Problems. In terms of the strict definitions of accounting, profit can be understood as revenue minus expenses. Expenses might include inventory costs, rent or other office overheads, staff, capital expenditure, and debt service. When issuing an invoice to a customer you create revenue, but only when your customer pays and you collect the funds in your bank account do you generate cash. Cash is what you have on hand to pay your bills at any given time. Effective management of cash flow will ultimately help to increase the profitability and sustainable growth of a business, but the two concepts are not the same. Cashflow can be divided into two categories:
- Accounts receivable: Money owed to you e.g. by customers and clients
- Accounts payable: What you owe to others e.g. your suppliers
Who is most susceptible to cash flow problems?
- A new business
- A seasonal business
- A small business