Why is it important to understand flows of cash as they move through your small business? Even if you don’t think you have a head for numbers, not keeping an eye on your cash needs is one of the quickest routes to business failure. Here are some key things for every small business owner to keep in mind about cash flow.
The difference between sales and cash
When you sell a product or service to a customer, you are entering into an exchange with that customer. The customer pays you or your business for this exchange — a sale has been made.
However, in any business transaction there can be a timing issue. You may not get payment for your product or service right away. This creates a cash crisis, when a business is caught without sufficient cash in the bank to pay bills, salaries, loan payments, and other important things. So even though you’ve made a sale, it doesn’t necessarily mean you have cash.
For example, you might have an outstanding invoice in your consulting business, and the client keeps promising you the cheque is in the mail. What if one day overdue becomes three weeks overdue? Can you pay yourself this month? Can you pay your employee salaries? (PS There are industry statistics from Statistics Canada and Dun and Bradstreet that tell you the average time it takes in your industry for customers to pay you.)
In the other direction, your business might owe another business, like a supplier, for inventory.
Both accounts receivable and accounts payable will impact your cash flow planning.
What is cash flow?
As it sounds, the flow of cash through the business during a period of time. Cash is your most important resource and you must keep a close eye on it, particularly during the start-up stage. Conducting a cash flow analysis is an important step in determining the overall feasibility of your business idea. The examples we gave above illustrate the importance of timing cash flows — proper cash management would enable you to have reserves to cover cash shortfalls.
Did we mention the average time to profitability for Canadian businesses is between three and four years? Yup. Three and half years is the average length of time it takes to establish a business, and for that business to have enough sales to cover its expenses. Yikes.
Want to learn more? Check out GoForth Institute’s online small business training.