Positive cash flow is essential for the success of your business. It means you have more money coming into your business than going out. These dollars are critical for your day-to-day operations and allow you to pay your employees, suppliers and creditors on time.
Cash flow is an important measure of the financial health of your business. Banks and investors will look at your cash flow, among other financial factors, when deciding whether to extend a loan or invest in your business.
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Cash flow and profit
Some small business owners initially focus on earning profit and overlook the importance of healthy cash flow. Profit is not the same as cash flow. Profit is the money you earn after deducting your expenses incurred for making the sale.
For example, if a customer makes a deposit for an order from your business, it represents a cash inflow but not profit. Profit is only realized after the product or service is delivered (and the expenses to create it are deducted).
Some business owners use their savings or a line of credit for emergencies. These can be costly options. Careful cash flow management and identification of potential shortfalls are important. You can have a profitable business with poor cash flow which can lead to late bill payments and poor supplier and creditor relationships.
6 ways to improve cash flow
- Align your accounts receivable to your accounts payable deadlines. If your supplier is expected to be paid in 30 days but you give your customer 60 days to pay, you may experience a cash shortfall.
- Offer incentives. Encourage customers to pay faster by providing a small discount, such as 2%, if they pay in full within a certain period. You may receive less money but improve the number of customers that consistently pay on time.
- Negotiate with suppliers. Suppliers, especially ones which you have a good, longstanding relationship with, may be open to flexible arrangements such as instalment payments or purchases using trade credit.
- Provide electronic payment options. Convenient options, such as online payment, could result in money being deposited into your account sooner compared to waiting for a cheque in the mail or making cash deposit trips to the bank.
- Lease or finance. Explore alternatives to buying such as leasing or financing as these options typically require less cash up-front and payment can be spread over months or years.
- Avoid too much inventory. Depending on your business and the business environment, maintaining lower inventory levels and re-ordering only when you need to can reduce cash outflows as well as save on storage costs.