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Keep the Cash Flowing in Your Small Business

Date: 2/1/2017

Author: Financial Hotline


Failure to properly plan cash flow is one of the leading causes of small business failures. Experience has shown that many small business owners lack an understanding of basic accounting principles. Knowing the basics will help you better manage your cash flow.

A (business’s monetary supply can exist either as cash on hand or in a business checking account available to meet expenses. A sufficient cash flow covers your business by meeting obligations (i.e., paying bills), serving as a cushion in case of emergencies, and providing investment capital.

The operating cycle is the system through which cash flows, from the purchase of inventory through the collection of accounts receivable. It measures the flow of assets into cash. For example, your operating cycle may begin with both cash and inventory on hand. Typically, additional inventory is purchased on account to guarantee that you will not deplete your stock as sales are made. Your sales will consist of cash sales and accounts receivable - credit sales. Accounts receivable are usually paid 30 days after the original purchase date. This applies to both the inventory you purchase and the products you sell. When you make payment for inventory, both cash and accounts payable are reduced. Thirty days after the sale of your inventory, receivables are usually collected, which increases your cash. Now your cash has completed its flow through the operating cycle and is ready to begin again

Cash-flow analysis should show whether your daily operations generate enough cash to meet your obligations, and how major outflows of cash to pay your obligations relate to major inflows of cash from sales. Thus, you can tell if inflows and outflows from your operation combine to result in a positive cash flow or in a net drain. Any significant changes over time will also appear.

A monthly cash-flow projection helps to identify and eliminate deficiencies or surpluses in cash and to compare actual figures to past months. When cash-flow deficiencies are found, business financial plans must be altered to provide more cash. When excess cash is revealed, it might indicate excessive borrowing or idle money that could be invested. The objective is to develop a plan that will provide a well-balanced cash flow. Your business can increase cash reserves in a number of ways:

- Collecting receivables - Invest time (and money) in quickly collect overdue accounts.

- Tightening credit requirements. Requiring cash only increases the cash on hand and reduces the bad debt expense. But be mindful tightening credit is helpful in the short run, it may reduce the ability of customers to purchase your product.

- Closely monitor price of products or services to understand your market, distribution costs, and competition. This will allow you to increase (or decrease) gradually as needed. Charge too little and cheat yourself. Increase too much or too fast and risk losing valuable customers.

- Short-term loans are often necessary for covering short-term cash-flow problems. Revolving credit lines and equity loans are common types of credit used in this situation.

- Increased sales would appear to increase cash flow. However, if large portions of your sales are made on credit, when sales increase, your accounts receivable increase, not your cash. Meanwhile, inventory is depleted and must be replaced. Because receivables usually will not be collected until 30 days after sales, a substantial increase in sales can quickly deplete your cash reserves.

You should always keep enough cash on hand to cover expenses and as an added cushion for security. Excess cash should be invested in an accessible, interest-bearing, low-risk account, such as a savings account, short-term certificate of deposit or Treasury bill.

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