It’s important to know what is affecting your cash flow. Most business owners understand that profitability and cash flow are not the same thing, but not all understand the reasons why. Here are a few of the biggest:
The biggest difference between cash flow and profitability for a small business owner is timing. You may be selling a widget for $1,000 that cost you $600 to make or buy. This makes you $400 in profit, but until you get paid your cash flow is -$600. Yes, this is a simple example, but it’s so common that it deserves an explanation.
If you’re buying widgets in advance, you’re holding on putting cash into your inventory. That’s important if you operate a business where the customer expects to receive the product instantly or quickly. Make sure you’re monitoring your inventory levels and not putting too much of your valuable cash here. A lot of work goes into doing this well, but your primary concern is really understands your business and its cycles.
If your customers usually pay you in 30 days, your cash flow slows down by that much. That may be acceptable, but if they start to unexpectedly stretch out upwards of 60- 90 days, that’s even more of your cash tied up in receivables. This can get out of hand very quickly and really strangle a business. It’s best to keep track of this very closely and address any late invoices as quickly as possible.
Your equipment eventually will need to be repaired or replaced. If unexpected, this can really mess with your cash flow, as expenses like this are typically substantial. Planning in advance for upgrades can help, and knowing where you stand can make it slightly less painful when something should come up unexpectedly.
This last reason is the most interesting because it’s universally accepted as a good thing, which it is. Just keep in mind that growth has an initial negative impact on cash flow. That’s because you are typically fronting the money for the increased demand of goods and services before you’re getting paid for them. If you’re growing very quickly and/or your terms are very long, a big need for cash to fund growth will arise. Make sure you’re prepared and know what you’ll need for reserves or back up so you can take advantage of the growth as it comes.
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