Watch Your Cash Flow – Especially in the Recession
The number one reason small businesses fail is because they don’t keep a sharp eye on their financial statements and fail to manage their cash flow. If you want to thrive in this recession as a small business owner, the best strategy you can employ is to manage your cash flow.
In order to manage your cash flow, you have to take a look at your income statement or profit and loss statement. Your bottom line is your net income or profit. But, your profit is not the money you have to spend. That’s your cash flow. Let’s look at the difference.
The income statement is based on accrual accounting. In other words, sales revenues and expenses are stated when they happen. So, if you sell a product to a customer on credit, you state the revenue you receive from that sale immediately, even though you haven’t collected the money yet. That’s the key issue. You don’t have the money yet. If you look at profit, then, as the money you have in your pocket, it’s overstated.
Cash flow is different from profit. It isn’t calculated using accrual accounting. It’s calculated using cash accounting. If you sell that same product to a customer on credit, you state the revenue only when you receive the payment for the product, not when you sell the product. As a result, the money you have in your pocket as a small business owner is your cash flow, not your profit.
It’s important for a small business to always have a cash cushion to rely on. You may receive a shipment of products and have to pay for it C.O.D. There may be a bargain in the marketplace that you should take advantage of. Prices of one of your primary raw materials may rise. For example, we know how volatile gas prices are. If you use a lot of gasoline for cars and trucks in your business operations, you need a cash cushion in case gas prices spike up unexpectedly. If you have a cash cushion, you don’t feel like you are so much at the mercy of the market.
What you need to do as a small business owner is convert your profit to cash flow in order to see where you stand and you need to do this often. Cash budgeting is best done monthly. You first look at your cash receipts (revenue) and take your accounts receivable (credit accounts) into consideration. Then, you look at your cash payments or the money you have paid out to your suppliers and others during the month. You may have paid items such as rent, lease payments, taxes, and other such fixed items. You also must take when you paid your suppliers into account.
If you would like to see an example of how to develop a cash budget, you can check out an example. Keep an eye on your financial statements and your cash flow, even though it may not be your favorite thing to do! Prepare monthly cash budgets. It will pay you big dividends in the end and may actually save your small business in this highly volatile economic environment.
Rosemary C. Peavler, Guide and Writer, bizfinance.about.com, a New York Times Company