One paradox that has plagued many startups, small and growing businesses is that they report profits, yet they still find it difficult to make do in the following months. While there might be many reasons for this phenomenon, the most likely concern lies with cash flows.
Negative cash flow can cripple a business to the point of bankruptcy. This is why many business technocrats have pointed cash flow to be the number 1 reason why small businesses fail.
The allure of profits over efficient cash flow has been the downfall for many a small business. Many owners rely on their profit and loss statements to determine whether their business is doing well. This write-up will illuminate why more businesses should consider using cash flow information rather than profit.
Cash Flow over Profits
A profit is the revenue gained after deducting the operating expenses from the total sales. Cash flow shows how much money comes in and goes out of business. Usually, profits are realized at the end of the financial year after drawing the profit and loss statement.
Cash flow, on the other hand, is normally a monthly occurrence as it logs day-to-day expenses and income in the books of account. Right away, any person with some business acumen will notice that the cash flow statement indicates the current position of the business. A profit, on the other hand, is a summary of the business over a particular period.
A cash flow statement only records the movement of cash. For instance, when A buys stocks from your business in cash, the transaction will be recorded as an inflow in the cash flow statement. When you purchase stock from C, the cash flow statement should indicate an outflow. However, if A had taken stock on credit, no entry would be made in the cash flow statement.
Credits sales will increase profit because, in the long run, a sale is still a sale where profits are concerned. However, credit sales reduce the liquidity of the business.
Where there is no money to run daily operations, then the expenses will surpass the income. Eventually, even profits realized will start to dwindle, leading to the collapse of a business.
The good news is that not all businesses have to fail due to the cash flow crisis. If you can reconcile the business’s profitability with cash flow, then your business does not have to fall to the cash flow crisis.
How To Fix a Cash Flow Crisis
When business owners do not have plan or strategy in place for managing shortage of cash inflow, it is called cash flow crisis. In such situation, you should be able to take quick actions and save your business from dying. Take these steps to fix cash flow crisis:
Have a Budget/Business Plan
It is important that from the incipient stages of your business to have a plan. A good entrepreneur should clearly map out the steps they are willing to take to keep the business afloat and to get ahead. Many businesses fall into the cash flow crisis because they want unplanned rapid growth. Having a budget will help a business owner know exactly how much to spend so as not to go overboard. A business plan will provide the roadmap for growth.
Cash Flow Statements
Cash flow statements are a vital tool to monitor your incoming and outgoing cash flow. Recording each cash transaction helps the business owner understand the cash traffic and also whether the business is able to sustain itself in the coming month. Cash flow statements can be tailored to suit the nature of the business. A cash-intensive business would do well with short period cash flow statements, while a less intensive business will still survive with longer reporting periods.
Businesses aim at growth. The blind lure of growth may, however, lead to the rapid downfall of a business. This is why forecasting is an important tool for any business. Basically, if you can monitor your cash flow now, it will be easy to tell what they will be in 3 or 4 months down the line using today’s data. An accurate forecast will help a business owner plan for the future and therefore account for any cash flow problems before they arise.
Cash reserves can help a business when cash flow is negative. However, this should be done with caution. Introducing new cash into the circulation will eventually increase expenses and in turn, reduce profit. This is because any extra money introduced becomes a liability. Cash reserves should only be sued as a last resort.
Consider Cash Flow against other financial statements
Like earlier discussed, the cash flow statement only shows cash transactions. It does not give a full picture of the position of the business. Information from other financial statements such as the balance sheet and profit and loss statement will complement the cash flow statement and therefore give an overall and accurate standing of your business.
Managing your cash flow is crucial to a business. Do not let profits fool you into a false sense of success. Where it seems a difficult task, hire an accountant, or use accounting software. The important thing is that you do not ignore the problem. The reason being ignoring the cash flow crisis can damage trust, and lenders who might want to associate with you will instead ask for immediate debt payments. Sooner you handle the situation and brainstorm the possible ideas; more likely you will survive the cash crises to keep your business intact.