7 May 2024
Cash Flow Monitoring: It's not just about profit!
If you want a business that can outlast the competition and stick around for the long haul, you need to track cash flow. Why is this so important, and how can it help you make better decisions?
Why is Cash Flow Monitoring Important?
Cash flow is the lifeblood of any business. That’s what makes cash flow monitoring so vitally important. It’s what tracks the money coming into the organization through different means, then measures that against your outgoing costs. This gives you the best and most accurate view of whether or not you’re making a profit, and whether you have enough money to pay your bills.
There are two kinds of cash flow.
- Positive cash flow- when the money coming into your business is more than the amount leaving
- Negative cash flow- when the money leaving your business is greater than the money coming in
Simply put, without cash flow monitoring, you won’t know if the business can keep operating. While some organizations can operate at a loss for a short period of time (particularly if they have capital investment coming in), this is rarely sustainable for the long term. Likewise, if you don’t have a picture of your cash flow for far enough in the future, you won’t be able to make any real strategic decisions.
Profit is not the same thing as cash, and this is a very important distinction to remember. Profit is simply an accounting term, a number you get when you reduce your revenue by your expenses. You can’t pay your bills with profit. A vendor won’t accept your profit and loss statement (P&L) as legal tender! Cash is needed to pay bills, so you need to actually collect it. Without this, you could wind up overspending, overtrading or even facing bankruptcy.
Cash flow is informed by several factors, including:
- Accounts receivable
- Accounts payable
- Capital expenditures
- Debts
Small business in particular can suffer from poor cash flow monitoring, and it’s a huge reason why only 44% of them last four years.
Best Practices for Cash Flow Monitoring
To start a more effective cash flow monitoring and improve your organizational health.
Trying to always keep a cash reserve (typically of three months, but some businesses may need more, particularly seasonal organizations) is very good practice, as it will help you deal with emergencies.
If you have an inventory, keep these records as up to date as possible, maximize your use of materials and reduce waste. Try to avoid ordering more inventory than you need, as this can really hamper your cash flow. A pile of physical assets that aren’t getting sold is not helping your cash flow.
Most important of all, cash flow is hugely impacted by your payment collection processes. You could have thousands of customers making purchases, but if they’re all going to pay you at a later date, your cash flow will suffer. For example, if you’re an invoice-based business, consider setting out clear deadlines for when payment is due. Make the act of paying you for goods and services rendered as easy as possible, so no customer falls through the cracks. Often, it’s not as simple as you might think.
Credit is often a huge issue when it comes to cash flow. Hypothetically, there’s a sale made and thus money coming in. Unfortunately, people can go bankrupt, default on payments, or have cash flow problems of their own, which means that money isn’t guaranteed to come to you. Always make sure you do your research before offering credit to a customer. This should take the form of credit checks and references.
Avoiding Cash Flow Pitfalls
The most common mistake made when it comes to cash flow is how most businesses think they can improve it. When a company says it wants to focus on growth to improve their cash flow, this is a huge red flag. Why? Because growth is one of the biggest drains on cash, as you often need to spend money to make it happen.
It makes logical sense but think about it for a second. The most common method to encourage growth is through increasing sales, but finding new customers can get very expensive, very quickly. Instead, you may want to look into selling more to your existing customers.
Increasing sales won’t solve immediate cash flow problems if these enter your accounts receivable. For example, if you sell a lot of items that are typically purchased on credit, that’s not going to give you more cash to work with.
Seasonal sales are also a big risk factor with cash flow monitoring. Know your market, and plan for each season accordingly. Establishing a line of credit can be very helpful here.
You can also attempt to mitigate the risks associated with poor cash flow management, which usually comes from reducing your expenses as much as possible. Evaluate what costs are essential to keep your business operating (such as rent and loans) and what can be cut back on, and you’ll give yourself some breathing room.
The Role of Cash Flow Monitoring in Financial Decision Making
You can’t have a truly healthy business without a clear picture of your cash flow, but one of them most important things to consider is how it can have a huge impact on your decision making.
Cash flow monitoring can also help with assessing the financial health and stability of a company. This makes it vital if you’re looking to secure more investment. Most investors are going to want to make sure you’re not in negative cash flow, so they know they’re not all that stands between you and bankruptcy.
You can also leverage cash flow insights for strategic planning and growth. Cash is needed to fund the vast majority of growth plans, as you need to invest it into various activities (Like
Cash flow will also help you create a more tailored budget. Projected cash flow statements aren’t foolproof, but they’ll give you a picture of where you might be overspending, underspending or where income isn’t where you need it to be. From there you can refine your day-to-day spending.
Consider asking:
- Is this year’s growth funded?
- Can we purchase new tools?
- Can we pay off debts faster?
- Can we look for new customers?
- Do we have more cash than we expected, and if so where should it go?
Leveraging Technology for Cashflow Monitoring
Historically, cash flow management has been handled by spreadsheeting software or even paper-based accountancy. This can often be quite sluggish, and without real-time reporting you can often find your cash flow statement doesn’t match your actual cash levels.
Ideally, you should be Integrating cash flow monitoring with existing financial systems. This ensures data can flow between the different systems without friction, ensuring accurate decisions can be made quickly.
A lot of the processes of cash flow monitoring can be made easier with the use of cloud-based finance software.
If you’d like to learn more, check out Finance from MHR, our suite of integrated software solutions that can ensure your cash flow is always where you need it to be.
