Cash flow management is an important aspect of personal and small business finances. In short, cash flow management is a process for controlling the cash inflow and outflow of available cash. Cash inflow is the amount of money a business has going into it, while cash outflow is money leaving the business. This process is essentially analyzing and monitoring the total amount of cash you receive minus the amount of cash spent.
With cash flow problems, business owners can have difficulty paying employees, vendors, and suppliers on time. In fact, 42% of small businesses say that cash flow management is among their top concerns. However, poor cash flow management can also be detrimental to people's personal lives.
This article focuses on the importance of cash flow management, providing tips to help readers manage their cash flow. Whether you're a small business owner wanting to adopt an effective cash flow management process or an individual wanting to learn financial management, continue reading.
Why Cash Flow Management Is Important
We've all heard the saying, "cash is king." Well, this statement is especially true when it comes to money management and having working capital. To avoid opening a line of credit, it's essential to ensure you have enough money on hand at all times. Without enough cash, businesses fail and individuals can experience financial hardships.
Effective cash flow management can help ensure that you don't lose your money and run into cash flow issues. As a business, this means you won't have to worry as much when a customer or client doesn't pay on time or continues to have outstanding late payments.
As an individual, understanding your cash flow can help you make better decisions by answering these questions:
- Am I able to invest surplus money into new projects or will I need this cash on hand?
- Do I need to apply for credit or can I purchase in cash?
- Can I grant credit or do I need to collect the cash right away?
- Should I ask for refinancing or can I pay off debts now?
All in all, cash flow management is among the most powerful steps you can take in ensuring the longevity of your personal or business finances. Effective cash flow management highlights what you're spending money on and the amount of cash you have available at all times. Knowing where you stand financially can help you make smarter personal and business decisions moving forward.
Tips for Managing Your Cash Flow Effectively
A positive cash flow empowers you to meet financial obligations and grow. With a positive cash flow, you have more money going into your business or personal savings than you need to spend (such as rent or payroll). When you no longer struggle with cash flow management, you'll be able to have the necessary cash balance on hand while also being able to put money back into investing or new projects.
As you can see, maintaining a positive cash flow allows for stress-free flexibility. Follow these tips for managing your cash flow.
Create an Emergency Fund
Life happens, and you'll want to be financially prepared for when it does. Although investing money back into your business and yourself is important, it can be hard to do so without an emergency fund. Before you begin investing, you should establish an emergency fund to cover unexpected expenses.
Emergency funds are made up of cash you've saved to be used for unexpected expenses. Whether covering a broken appliance, fender bender, or rent, an emergency fund can help during financial emergencies. The amount every individual needs depends on their financial situation. Regardless of the amount you decide to set aside, you should set a specific goal for your emergency fund. Most financial experts agree that saving between three and six months' worth of expenses is best.
For businesses, it's recommended to save 10% to 30% of annualized revenue. This amounts to roughly three to six months of liquidity, which can be used in case of an emergency. Instead of quickly reacting to uncertainty, experts believe that having an emergency fund to fall back on can help you to make good financial and business decisions.
Determine Your Financial Health
How do you determine your financial health? Whether it's for your small business or personal finances, creating a cash flow statement can help you understand your finances. Cash flow statements show how much money is coming in and where it's going during an accounting period.
Consistently keeping track of your cash flow allows you to identify any inefficiencies. The cash flow statement provides you with an overview of what you receive and what you spend. Comparing cash flow statements weekly or monthly can help you understand your financial health. Luckily, creating cash flow statements isn't difficult. The right accounting software can simplify this process, making it easier to manage your small business or personal finances.
Additionally, businesses should consider calculating their profitability. Although there are various types of profit margin, net profit margin is the most common. This is a business's bottom line once all other expenses have been subtracted from the revenue. The profit margin represents a percentage of sales that have been converted into profits for the business.
Identify Whether You Have a Negative Cash Flow or Positive Cash Flow
When it comes to having effective cash flow management, you'll want to ensure a positive cash flow. A positive cash flow occurs when there is more money coming in than going back out. On the other hand, a negative cash flow occurs when more cash is going out than coming into your business or personal account.
Identifying whether your cash flow is positive or negative can be a sign of future stability. For example, if your cash flow is consistently negative, it's an indication that you will have difficulty paying for expenses down the line and will use up your cash reserves. You may also find that you make enough to cover your expenses, but the timing is off. You might find yourself running low on funds at the end of the month and struggle to make it to payday. Tracking how you manage your cash flow can help you save extra money so that you won't have to struggle between pay periods.
Make Cash Flow Projections
Experts recommend that you closely monitor your company's cash by looking at key data and variables. By monitoring your company's cash, you can make better cash flow predictions.
To do so, you'll need to create a cash flow forecast. This method requires that you forecast sales and expenses for a specific accounting period. It should include payment histories, averages and trends, and economic and business conditions.
Create your cash flow projections by estimating monthly cash inflows and outflows. Then, compare and revise your budgeting based on the actual inflow and outflow for the month.
Assess Your Personal and Business Needs
Once you've determined your financial health and can make cash flow predictions, you should assess your personal and business needs. With a credit card, it's easy to spend more than you anticipated and be surprised when you see the month's statement. To avoid overspending, you can create personal financial statements. Financial statements are a method of accounting for income and expenditures. A personal cash flow statement indicates your financial condition and can help you with budgeting.
Cash flow statements measure the cash inflow and outflow to show your net cash flow. Generally, cash inflow includes your salary, while cash outflow includes expenses like gas and rent.
Just as with personal finances, assessing your business needs can help you cut costs. For example, let's say a startup owns a large mixer to produce bath bombs. However, the large mixer continually breaks and has shortfalls that are becoming a financial burden.
In the short term, budgeting has been adjusted to account for the added costs. However, the constant repair fees are contributing to a negative cash flow. To avoid an increase in pricing for the bath bombs, the small business decides to start leasing equipment. Since the cash flow was tight, fixing or purchasing a new mixer would have been a bad decision. Instead, opting to lease the mixer was the best business decision.
Always Manage Income and Expenses
Next, you should always be on top of your income and expenses. By creating an income statement, you can see your earnings, expenses, and revenue for a designated accounting period. When combined with a cash flow statement and balance sheet, you can see the total picture of your financial performance.
Include Payment Terms on Invoices
To ensure money is flowing back into your business when expected, all invoices should include payment terms. Payment terms include the exact date you plan to be paid. Including this information on the invoice ensures that the customer is aware of when they must pay you.
Using Skynova's invoice template can simplify this process. With a space already provided for the invoice terms, you can just add the payment date and be finished. When invoicing, you can also include payment methods so customers know if you accept check, cash, debit, or credit card.
To encourage customers to pay you in a timely manner, send invoices as soon as the products or services are delivered. To prevent missed payments, you can set up payment reminders for all customers. Some recommend sending reminders seven to two days before their payment is due. If payments are missed, make sure to follow up as quickly and professionally as possible.
Get Help From a Professional When Needed
In some cases, you may want the help of financial professionals. Although you can manage your cash flow easily by using accounting software, there is a time and a place for professional help. If you're finding it difficult to effectively manage your cash flow, there's no shame in asking for help. At the end of the day, you want to ensure that you have control over your personal and business cash flow.
Keep Your Finances in Order With Accounting Software From Skynova
As a small business owner or individual, keeping track of finances can be a dizzying experience. However, it's the digital age, and there are solutions to improve your financial processes. Track and manage income and expenses from one, completely customizable accounting software. Whether you want access to a quick overview of your finances or an in-depth view, Skynova's accounting software was specifically designed for people like you in mind.
Notice to the Reader
The content within this article is meant to be used as general guidelines for cash flow management and may not apply to your specific situation. Always consult with a professional accountant to ensure you're meeting accounting standards.