Liquidity, and not profitability, is one of the main reasons start-up businesses fail.
Liquidity is a measure of your business’ ability to cover its immediate and short-term obligations.
Cash flow is the money moving in and out of your business. If more money is moving in than out, your business is experiencing a positive cash flow.
If more cash is going out than coming in, like when you are just starting a business, you may need some temporary sources of cash to keep you going until you get you and your business into a positive cash flow situation.
Remember these three things when forecasting and managing your cash flow:
1. Cash flow management should forecast your cash requirements
A Cash Flow Statement records all the money coming into your bank account (or cash on hand), all money flowing out of your bank (or cash on hand) and forecasts when there is a surplus or shortfall.
Examples of cash inflow are: when a client pays their account, and not when you make the sale on account; when you make a cash sale; and when you invest capital into your business.
Examples of cash outflow are: when you buy stock for cash; pay for stock bought on account; pay your expenses; or repay a loan.
2. Cash flow versus profitability
All transactions that affect profitability do not necessarily affect cash flow.
Two examples of the above are:
Depreciation – is a book entry and not a cash transaction - and
Cost of sale - this expense happens as and when you make a sale, but you may have paid for item at a different time.
3. Some cash flow movements do not affect profitability
There are some transactions which do not affect profit and loss, but do affect cash flow.
For example, the instalment on an HP (An HP is a special loan agreement when purchasing equipment or vehicles on credit) does not affect profit and loss, but because it is a payment, it affects the cash flow.
The payment of an installment on a loan has a similar effect.
The life-blood of a business
Just as a human cannot survive with an insufficient amount of blood, a business cannot continue to operate with insufficient working capital, the life-blood of a business.
Cash is an important element of working capital.
The Working Capital of a business comprises CASH (including money in the bank), together with stock, debtors and creditors.
**Make sure to catch The Springboard Academy’s next blog post about other assets and liabilities.