This short guide will help you understand cash flow the way businesses need to – right from how to manage the cash and where to find it if your cash reserves dry out.<\/p>\r\n\r\n\r\n\r\n
What is cash flow for small business?<\/strong><\/h2>\r\n\r\n\r\n\r\nCash flow or Working Capital is a financial metric which represents operating liquidity available to a business. Or, to put it simply, cash flow is the money a business uses for its day-to-day operations. It is the amount of money held up in operations.<\/p>\r\n\r\n\r\n\r\n
It is an indicator of the short-term financial position of a business and a measure of its overall efficiency.<\/p>\r\n\r\n\r\n\r\n
The basic formula you need to know to understand cash flow\/working capital better:<\/h6>\r\n\r\n\r\n\r\n\r\n- Working Capital = Current Assets \u2013 Current Liabilities\u00a0\r\n\r\n<\/li>\r\n
- Working Capital Ratio = Current Assets \/ Current Liabilities<\/li>\r\n<\/ul>\r\n
Cash flow cycle: A cash flow cycle <\/strong>is the\u00a0time it takes for a business to convert the net current assets and liabilities to cash.<\/p>\r\n\r\n\r\n\r\n\r\n![\"Cash](\"https:\/\/www.instamojo.com\/blog\/wp-content\/uploads\/2020\/01\/Cash-flow-small-businesses-2-.png\" "\\"Cash")
\r\nAn example of how working capital cycle functions – Source: Brighthub<\/figcaption>\r\n<\/figure>\r\n<\/div>\r\n\r\n\r\n\r\nImportant tip from our expert, Mr. Ranganath Iyenger, CA – The longer the cycle, the longer a business is tying up capital in its working capital without earning a return on it.<\/blockquote>\r\n\r\n\r\n\r\nPositive cash flow:<\/strong><\/h5>\r\n![\"\"](\"https:\/\/www.instamojo.com\/blog\/wp-content\/uploads\/2020\/01\/cash-flow.jpg\")
<\/p>\r\n\r\n\r\n\r\n
Your cash flow is positive when the money coming in from sales, accounts receivable is more than the amount you use to pay your vendors, employees and spend money on purchase inventory or raw materials.<\/p>\r\n
Cash inflows exceed cash outflows when a company has a positive cash flow. In other words, a positive cash flow indicates that the business is bringing in more money than it is losing, which is crucial to its long-term success.<\/p>\r\n\r\n\r\n\r\n
Negative cash flow:<\/strong><\/h5>\r\n![\"\"](\"https:\/\/www.instamojo.com\/blog\/wp-content\/uploads\/2020\/01\/statement-of-cash-flows.png\")
<\/p>\r\n
Source: Wallstreetmojo<\/a><\/p>\r\n\r\n\r\n\r\nThe exact opposite. A negative cash flow happens when your outflow of cash is more than the cash coming into your business. This does not spell good for a business, but there are steps you can take to fix it.<\/p>\r\n
An organization’s cash flow is negative when it spends more than it brings in. The sales you make cannot cover all your expenses. Financing and investments are the best ways to obtain the necessary funds.<\/p>\r\n\r\n\r\n\r\n
Cash flow positivity vs Profitability<\/strong><\/h2>\r\n\r\n\r\n\r\nNot many small businesses know this, but there is a lot of difference in being cash flow positive and cash flow profitable. The two concepts are easily misinterpreted and often misused interchangeably.<\/p>\r\n\r\n\r\n\r\n
How to know when your business is cash flow positive:<\/strong> The money coming in and out of your business on any given day is more than the money going out.<\/p>\r\n\r\n\r\n\r\nHow to know your cash flow is profitable:\u00a0 <\/strong>Your income or net revenue is more than your expenses.<\/p>\r\n\r\n\r\n\r\nWhat is the difference between Cash Flow Positivity vs Profitability?<\/strong><\/p>\r\n\r\n\r\n\r\nA business can be cash-flow positive but may not be profitable. Also, it is possible that a business is profitable but is not cash flow positive.<\/em><\/p>\r\n\r\n\r\n\r\nKeep in Mind:<\/strong><\/p>\r\n\r\n\r\n\r\nCash flow records inflow and outflow of money. For example:<\/strong><\/em><\/p>\r\n\r\n\r\n\r\nYou manufacture your product\/service for Rs.500 send out an invoice for Rs. 1000.\u00a0 You are yet to be paid for this.<\/p>\r\n\r\n\r\n\r\n
This entry will be made in your Profit and Loss statement but will not be counted as a cash inflow because you haven\u2019t received the payment yet.<\/p>\r\n\r\n\r\n\r\n
In this scenario – you are still not cash flow positive but you\u2019re profitable by Rs. 500.<\/em><\/strong><\/p>\r\n\r\n\r\n\r\nSmall business cash flow – How much working capital do you need?<\/strong><\/h3>\r\n\r\n\r\n\r\nAccording to Strategic interventions Research, Working capital has a direct impact on the cash flow of a business. Small businesses need to know how to balance their working capital – because too much working capital is a bad sign too.<\/p>\r\n\r\n\r\n\r\n
\r\n- From a planning perspective, most businesses provide for up to 2 months requirement of working capital and keep about 1 month in contingent reserves.<\/li>\r\n
- Most common sources of working capital (short term) are Equity, Trade Creditors, Factoring, Line of Credit and Short-term loan (< 1 year)<\/li>\r\n
- Laws for MSMEs mandate that they should be paid within 45 days which is the maximum credit extended.<\/li>\r\n<\/ul>\r\n\r\n\r\n\r\n
How to fix cash flow problems for small businesses?<\/strong><\/h2>\r\n\r\n\r\n\r\nSmall businesses can maintain cash flow by:<\/p>\r\n\r\n\r\n\r\n
\r\n- Determine your breakeven point<\/li>\r\n
- Focus on cash flow management, not just profits<\/li>\r\n
- Maintain up to 1-month cash reserves Use a cash flow worksheet<\/li>\r\n
- Monitor your work in progress, complete and bill timely<\/li>\r\n
- Collect receivables within 45 days<\/li>\r\n
- Encourage customers to pay faster<\/li>\r\n
- Extend payables to the extent possible<\/li>\r\n
- Designate an employee to monitor cash flows<\/li>\r\n
- Liquidate Cash tied up with Assets that are not in use<\/li>\r\n
- Pay suppliers on time to maintain negotiating leverage and terms<\/li>\r\n
- Control expenses carefully especially the small ones<\/li>\r\n
- Watch your inventory and ensure it is neither excess nor short<\/li>\r\n
- Talk to alternative lenders to optimize working capital cost \u2013 banks, financial services firms, trade finance firms, factoring firms etc.<\/li>\r\n
- Emergency loans<\/a> (short term loans) can help to tide over seasonal increases or one-off large orders even if the interest cost is a little high<\/li>\r\n
- Asset-based financing is always useful as it gives you more leeway and if you are using real estate, you can always re-value and increase the collateral once in 3-5 years.<\/li>\r\n<\/ol>\r\n\r\n\r\n\r\n
Types of working capital loans for your business:<\/strong><\/h3>\r\n\r\n\r\n\r\n
- \r\n
- Working Capital = Current Assets \u2013 Current Liabilities\u00a0\r\n\r\n<\/li>\r\n
- Working Capital Ratio = Current Assets \/ Current Liabilities<\/li>\r\n<\/ul>\r\n
Cash flow cycle: A cash flow cycle <\/strong>is the\u00a0time it takes for a business to convert the net current assets and liabilities to cash.<\/p>\r\n\r\n\r\n\r\n
\r\n\r\nAn example of how working capital cycle functions – Source: Brighthub<\/figcaption>\r\n<\/figure>\r\n<\/div>\r\n\r\n\r\n\r\n Important tip from our expert, Mr. Ranganath Iyenger, CA – The longer the cycle, the longer a business is tying up capital in its working capital without earning a return on it.<\/blockquote>\r\n\r\n\r\n\r\n
Positive cash flow:<\/strong><\/h5>\r\n
<\/p>\r\n\r\n\r\n\r\nYour cash flow is positive when the money coming in from sales, accounts receivable is more than the amount you use to pay your vendors, employees and spend money on purchase inventory or raw materials.<\/p>\r\n
Cash inflows exceed cash outflows when a company has a positive cash flow. In other words, a positive cash flow indicates that the business is bringing in more money than it is losing, which is crucial to its long-term success.<\/p>\r\n\r\n\r\n\r\n
Negative cash flow:<\/strong><\/h5>\r\n
<\/p>\r\nSource: Wallstreetmojo<\/a><\/p>\r\n\r\n\r\n\r\n
The exact opposite. A negative cash flow happens when your outflow of cash is more than the cash coming into your business. This does not spell good for a business, but there are steps you can take to fix it.<\/p>\r\n
An organization’s cash flow is negative when it spends more than it brings in. The sales you make cannot cover all your expenses. Financing and investments are the best ways to obtain the necessary funds.<\/p>\r\n\r\n\r\n\r\n
Cash flow positivity vs Profitability<\/strong><\/h2>\r\n\r\n\r\n\r\n
Not many small businesses know this, but there is a lot of difference in being cash flow positive and cash flow profitable. The two concepts are easily misinterpreted and often misused interchangeably.<\/p>\r\n\r\n\r\n\r\n
How to know when your business is cash flow positive:<\/strong> The money coming in and out of your business on any given day is more than the money going out.<\/p>\r\n\r\n\r\n\r\n
How to know your cash flow is profitable:\u00a0 <\/strong>Your income or net revenue is more than your expenses.<\/p>\r\n\r\n\r\n\r\n
What is the difference between Cash Flow Positivity vs Profitability?<\/strong><\/p>\r\n\r\n\r\n\r\n
A business can be cash-flow positive but may not be profitable. Also, it is possible that a business is profitable but is not cash flow positive.<\/em><\/p>\r\n\r\n\r\n\r\n
Keep in Mind:<\/strong><\/p>\r\n\r\n\r\n\r\n
Cash flow records inflow and outflow of money. For example:<\/strong><\/em><\/p>\r\n\r\n\r\n\r\n
You manufacture your product\/service for Rs.500 send out an invoice for Rs. 1000.\u00a0 You are yet to be paid for this.<\/p>\r\n\r\n\r\n\r\n
This entry will be made in your Profit and Loss statement but will not be counted as a cash inflow because you haven\u2019t received the payment yet.<\/p>\r\n\r\n\r\n\r\n
In this scenario – you are still not cash flow positive but you\u2019re profitable by Rs. 500.<\/em><\/strong><\/p>\r\n\r\n\r\n\r\n
Small business cash flow – How much working capital do you need?<\/strong><\/h3>\r\n\r\n\r\n\r\n
According to Strategic interventions Research, Working capital has a direct impact on the cash flow of a business. Small businesses need to know how to balance their working capital – because too much working capital is a bad sign too.<\/p>\r\n\r\n\r\n\r\n
- \r\n
- From a planning perspective, most businesses provide for up to 2 months requirement of working capital and keep about 1 month in contingent reserves.<\/li>\r\n
- Most common sources of working capital (short term) are Equity, Trade Creditors, Factoring, Line of Credit and Short-term loan (< 1 year)<\/li>\r\n
- Laws for MSMEs mandate that they should be paid within 45 days which is the maximum credit extended.<\/li>\r\n<\/ul>\r\n\r\n\r\n\r\n
How to fix cash flow problems for small businesses?<\/strong><\/h2>\r\n\r\n\r\n\r\n
Small businesses can maintain cash flow by:<\/p>\r\n\r\n\r\n\r\n
- \r\n
- Determine your breakeven point<\/li>\r\n
- Focus on cash flow management, not just profits<\/li>\r\n
- Maintain up to 1-month cash reserves Use a cash flow worksheet<\/li>\r\n
- Monitor your work in progress, complete and bill timely<\/li>\r\n
- Collect receivables within 45 days<\/li>\r\n
- Encourage customers to pay faster<\/li>\r\n
- Extend payables to the extent possible<\/li>\r\n
- Designate an employee to monitor cash flows<\/li>\r\n
- Liquidate Cash tied up with Assets that are not in use<\/li>\r\n
- Pay suppliers on time to maintain negotiating leverage and terms<\/li>\r\n
- Control expenses carefully especially the small ones<\/li>\r\n
- Watch your inventory and ensure it is neither excess nor short<\/li>\r\n
- Talk to alternative lenders to optimize working capital cost \u2013 banks, financial services firms, trade finance firms, factoring firms etc.<\/li>\r\n
- Emergency loans<\/a> (short term loans) can help to tide over seasonal increases or one-off large orders even if the interest cost is a little high<\/li>\r\n
- Asset-based financing is always useful as it gives you more leeway and if you are using real estate, you can always re-value and increase the collateral once in 3-5 years.<\/li>\r\n<\/ol>\r\n\r\n\r\n\r\n
Types of working capital loans for your business:<\/strong><\/h3>\r\n\r\n\r\n\r\n
- Asset-based financing is always useful as it gives you more leeway and if you are using real estate, you can always re-value and increase the collateral once in 3-5 years.<\/li>\r\n<\/ol>\r\n\r\n\r\n\r\n