Cash flow. This popular term gets thrown around a lot, both in business and everyday life. But do you know what it actually means? And more importantly, how it impacts your small business?
Whether your cash flow knowledge is zero, so-so, or pretty good but needs a refresher, we’ve got you covered. In this post, we’re getting into the nitty gritty of cash flow, what it is, why it matters, real-life examples, how to keep yours in the pink, and tools for making cash flow management a breeze. Which is handy, because (spoiler alert) the survival of your business depends on it.
So, what exactly is cash flow?
Cash flow is just what it sounds like: a measurement of the flow of cash (or cash equivalents) in and out of your business over a set period of time. When more cash is coming in than going out, it’s known as positive cash flow. On the flip side, when the outgoing cash exceeds the incoming cash, it’s called negative cash flow.
It’s hard to overstate the importance of appropriate cash flow management, but this statistic helps shed some light: 82% of shuttered small businesses cite cash flow issues as the reason for their failure.
And proper cash flow management isn’t just about keeping your business afloat. It’s about making it resilient, flexible, and predictable. For instance, having a handle on your cash flow allows you to:
- Forecast expenses
- Prepare for slow months
- Set and adjust your prices
- Gain clarity on your spending
- Make timely payments to your vendors
- Know when you’re ready to scale up
What’s the difference between cash flow and profit and loss?
Although cash flow may sound pretty similar to another common business term — profit and loss, or P&L — they’re not the same.
So, what’s the difference between cash flow and P&L? Here’s a quick side-by-side comparison.
Given these differences, it’s entirely possible to have a positive cash flow without being a profitable business, and vice versa. Let’s look at some real-life examples of how this works.
Real-life examples of cash flow
Imagine you’re opening a pet grooming business. You make a business plan and get a small business loan from a local bank in the amount of $50,000. That loan represents money flowing into the business, producing a positive cash flow. But if you don’t book any dogs or cats for your first two months, you’re not generating revenue, which means your profitability is nil. Positive cash flow, without being profitable.
The reverse is also true. You can have a negative cash flow, while being profitable. Let’s say you sell second-hand cars, and most of your customers use the buy now, pay later option. You pay for $1,000 for a car, then resell it for $1,500, with the customer paying $500 down and $1,000 due in six months. Even though you sold the car for a $500 profit, the cash generated from the sale is $500 and the rest is “accounts receivable.” Your cash reserves have actually gone down by $500 even though you netted a profit from the sale. Negative cash flow, while being profitable.
It’s worth noting that negative cash flow puts business owners in a real pickle, no matter how many assets or accounts receivable they’re owed. It’s essential to have sufficient liquid cash on hand to pay your vendors and meet your financial obligations as a business. In other words, profit alone isn’t enough. Positive cash flow is a must for keeping your business healthy and in a position to grow.
How to manage a positive cash flow
Now, let’s get to the good stuff: how to protect and grow your business by properly managing a positive cash flow. Here are some tried-and-true cash flow strategies.
Make payment terms work for you
The longer you can hold onto your cash reserves, the better. So when it’s time to pay your vendors, send payment as close to the due date as possible, without crossing over into late payment territory. That way, you maximize your cash flow while still keeping your financial commitments.
Consider the cost of goods sold
Making adjustments to the cost of goods sold is a simple but effective way to bring more cash into your business. Buying in bulk and finding a more affordable supplier are two of the most common methods, but feel free to get creative when it comes to reducing your expenses.
Handle late payments properly
Late payments can throw off your cash flow, so make sure your clients and customers are crystal clear about when their payments are due. Outline the payment date from the get-go, using dates rather than vague terms like “upon receipt.” It also helps to send a reminder before the due date, to nudge it back onto their radar if it’s fallen off. Charging late fees for overdue payments is another way to protect your cash flow and give clients a reason to pay on time.
Simplify your cash flow management with Melio
When it comes to your business, the old saying is true: cash is king. You can avoid joining the 82% of small businesses who closed their doors due to cash flow by getting — and staying — on top of yours.
And it doesn’t have to be difficult. Melio makes cash flow management easy for small business owners and solopreneurs by putting time- and sanity-saving tools at your fingertips. With Melio, you can schedule outgoing payments in advance, send invoices and reminders with just a few clicks, and even set up two-way sync with QuickBooks to generate up-to-date cash flow reports whenever you need them.
To find out more about Melio and how this easy and intuitive platform can help you manage your cash flow, sign up today or schedule a live demo.
*This blog post is intended for informational purposes only and is not intended as financial advice.
**Melio does not provide legal, tax or accounting advice, and you should consult with a professional advisor before making any financial decisions.