Positive cash flowCash flow The sums of cash a business gets in and spends out during a set period of time.+ read full definition 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 loanLoan An agreement to borrow money for a set period of time. You agree to pay back the full amount, plus interest, by a set date.+ read full definition or investInvest To use money for the purpose of making more money by making an investment. Often involves risk.+ read full definition in your business.
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 creditLine of credit An account that you set up with a financial institution (often a bank) to borrow money. It lets you borrow what you need, when you need it, up to a certain limit.+ read full definition for emergencies. These can be costly optionsOptions An investment that gives you the right to buy or sell it at a set price by a set date. The buy right is termed a “call” option, and the sell right is termed a “put” option. You buy options on a stock exchange.+ read full definition. 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 creditorCreditor A person or institution that lends money. To borrow from a bank or finance company, you must sign a legal contract that gives them the right to claim your car, home or other assets if you don’t pay back the loan.+ read full definition 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 discountDiscount When something sells for less than its normal price.+ read full definition, 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 tradeTrade The process where one person or party buys an investment from another.+ read full definition credit.
- Provide electronic payment options. Convenient options, such as online payment, could result in money being deposited into your accountAccount An agreement you make with a financial institution to handle your money. You can set up an account for depositing and withdrawing, earning interest, borrowing, investing, etc.+ read full definition 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.