What is Cash flow?
Cash flow refers to the amount of cash coming in and going out of your business over a period of time. A positive cash flow means you have more cash coming into your business than cash going out of it. Having a positive cash flow helps to ensure your business meets existing financial obligations.
Normally, business owners or auditors will use the cash flow statement to get an idea of a business's financial health.
A healthy Cash Flow?
While businesses always seek to maintain positive cash flow to ensure their day-to-day operation is not affected by a lack of cash, a positive cash flow does not definitively mean they have a healthy cash flow. Having a negative cash flow suggests that you may not have enough funds to pay your staff and suppliers, however, having too much cash may also suggest that you're not using enough funds for expansion and your business will be at risk of losing out in near future. Hence, you'll need to find a balance between the amount of cash you reserve and the amount of cash you spend.
Here is a simple checklist to help you check the health of your cash flow.
Checklist for a healthy cash flow
1. Purchase and selling prices
Before looking at the cash flow statement, you'll need to review your purchase and selling price to ensure you're earning a fair amount of profit margin. One common mistake that business owners make is not adjusting their selling price quick enough to reflect an increase in the purchase price. With inflation and the rising cost of goods and services, it is highly possible that your item cost price will increase as well.
Hence, it is crucial that you monitor your purchase and selling prices from time to time to make sure your profit margin is not squeezed by the rising cost. You can also use a system like TreezSoft Cloud Accounting to easily keep track of your stock value from time to time.
The idea is that your profit should be at least enough to cover all your operation costs and cost of goods.
2. Payment term with your suppliers
The next thing you need to check is the payment term with your suppliers or account payable on the cash flow statement. For large payable amounts, it is also wise to check for an installment plan with your suppliers. You can plan and negotiate the payment with your suppliers so that you won't have to face multiple bills all due at the same time and do not have enough funds to make the payments.
A good practice is to spread out the payable time for each bill and plan your cash flow accordingly to make sure you have enough funds to pay each bill before the due dates.
3. Payment terms with your customers
Other than the account payables, you'll also need to check the account receivables and make sure you are receiving money from your customers quickly enough. If your account receivables are clearing off too slowly, you will need to check the payment term and also the process of billing your customer.
You should adjust the payment term to be shorter for customers with lower credibility. Besides, you can also keep track of outstanding bills and send reminders to your customers to ensure they pay on time. These steps may look simple but will have a great impact on your business cash flow.
4. Is your cash being used effectively?
Last but not least, you'll need to analyze your cash flow statement regularly. A good practice is to analyze the cash flow statement at least once every month so that you can promptly identify any underlying issue.
When analyzing the cash flow statement, check for areas where you're spending more than you're supposed to and places where you're spending too little for an effective business expansion. Are you spending on ineffective marketing? Are there any services or products that were not effective for your business? Or are you not spending enough on to digitalize and simplify your business operation so that you can focus your human resources on the new market? These are the questions you have to ask yourselves when analyzing the cash flow statement.
While expanding your business is exciting, as it means a new market and a high possibility of more revenue, if you expand in the wrong way or wrong time, you're most likely to have more problems than benefits in the long run. Hence, ensuring you have enough cash to cover the right expansion is important. Business owners will have to manage their cash flow effectively to ensure business sustainability.
It is clear that maintaining a healthy cash flow is vital for all businesses. As a business owner, you have to make sure you are using your cash efficiently by maintaining a balance between cash reserved and cash used for business expansion.
You can also visit the links below to read more on related topics in TreezSoft:
TreezSoft is a cloud accounting software for Small and Medium-sized Enterprises (SMEs). It allows you to access your financial information anytime, anywhere. It also allows you to have unlimited users for FREE for your account in TreezSoft. Our aim is to help reduce our clients' time spent on accounting mainly by using our automated processes and integration to help increase their company efficiency at a minimum cost. SMEs can use TreezSoft to keep track of their expenses, accounts, daily operation e.g. Point of Sales (namely QPOS) system and etc.
Visit TreezSoft at http://www.treezsoft.com/ to sign up for a 30 days trial account with us!
You can also email us at [email protected] for more inquiries.