Businesses, as varied as hair salons, pet food distributors, and software testing services all, have one thing in common: those who run them need to employ sound business practices. As a business owner or manager, you may hear a lot of advice about proper budgeting, and with good reason. You can’t spend more than your business makes and a budget helps you stay on track with revenue versus expenditures.
Yet, budgeting has limitations because it only tells part of the story. Your weekly, monthly, or quarterly budget is just a snapshot of that period. To get a better picture of your company’s finances over time, pay attention to cash flow.
Why Cash Flow Is So Important
To understand why cash flow is so important, let’s consider an example. Say your hair salon has been in operation for three years and you’ve recognized some patterns. For example, every January, revenue declines because people want to save money after holiday spending and many of your stylists take time off.
When you examine your cash flow, typically by creating a spreadsheet, you can plug in the revenue you expect for this time in the upcoming year. You can also plug in expected expenditures for that time, such as those new automatic hair dryers you’ve been wanting to purchase.
The result is that, if you make the purchase, you end up with less than you need for regular expenses such as payroll and rent.
With this knowledge, you can act accordingly, such as putting off the hairdryer purchase or setting aside a little extra cash in the months leading up to the slow time at the beginning of the year. When you plan using cash flow analysis, you can be proactive and financial problems within your business become rare.
Cash Flow Scenarios
As an example in the previous section shows, cash flow analysis is useful for every-day business planning. It’s also helpful for special scenarios, such as paying off debt or building up savings.
Maybe you’ve purchased a new piece of equipment on a 12-month payment plan. Using your cash flow worksheet, you can plug in the payments you need to make for the next year. As you do the calculations, you can see how these payments affect other aspects of your finances. Maybe you need to cut back on another expense, or maybe you learn that you can afford to pay more than the minimum each month and reduce the debt faster.
Your process would be similar if you want to build up savings. You would plug in the amount of this “payment” each month and see how it impacts your other obligations. It could be that you can afford to save for several months, but then need to use some of that savings to cover a large tax payment.
How to Manage Cash Flow
The simplest way to get started with your cash flow analysis is to create a cash flow spreadsheet. You can download a template from an online source or open one in Excel. Next, populate the template with information from your business. Then watch as the calculations reveal peaks and valleys in your cash flow.
Armed with this valuable data, you can make adjustments to ensure all your obligations are met, even during dips in revenue. This is where the cash flow method takes budgeting to the next level. While budgets set up rigid spending categories and dollar amounts, cash flow projections allow for flexible adjustments. Your next steps might include:
- Instituting a savings fund to cover future revenue dips
- Paying off debts faster or slower
- Planning the best times to make large purchases
- Planning new marketing programs to bring in more revenue during typically slow periods
- Planning when to hire new staff or contractors
You’ll need to update your cash flow spreadsheet regularly, taking into account any surprises (such as equipment maintenance expenses) that change your forecast or plans.
Cash Flow Benefits
Once you have a cash flow analysis in place, many things are possible for your business. For example, you have a clear picture of your financial standing, so you can make a good impression on lenders and investors when you need extra cash. You can see when a good time might be to launch major initiatives or expand the business or determine when you might need to seek out a new supplier.
You can easily tell what spending areas you might need to expand or reduce or what areas of the company are taking up more than their share of resources. You can also quickly see the outcomes of hypothetical scenarios based on new business ideas.
Budgeting is useful in business, but it can be limited. With budgeting, you create fixed amounts of money to spend on various categories that may not be appropriate every month, quarter, or year. Cash flow adds a time factor to budgeting, giving it another dimension that can help you make better business decisions now and into the future.
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