While your start-up may be generating healthy sales, it’s crucial to remember that without a consistent inflow of cash, you may struggle to cover your operational expenses. Managing your cash flow and budgeting wisely are key practices to ensure you have enough funds to meet your financial obligations.
In this lesson on basic budgeting and cash flow management, we will explore the essential strategies for maintaining a healthy financial position. We will delve into the process of creating a budget that aligns with your business goals and helps you allocate resources effectively. Additionally, we will discuss the significance of monitoring your cash flow closely to identify potential challenges and take proactive measures.
By adopting these fundamental financial practices, you will be equipped with the knowledge and skills to make informed decisions, proactively manage your cash flow, and avoid running into financial difficulties.
Let’s delve into the world of basic budgeting and cash flow management, empowering you with the tools and insights to ensure the financial stability and success of your business.
Managing budgets
Effective budget management is crucial for the financial health of your business; and cash flow serves as the lifeblood of your operations, making it essential to establish a reliable system for tracking incoming and outgoing funds right from the start. These financial figures serve as the foundation for estimating your cash needs at any given time to meet your expenses.
Regularly comparing the actual cash flow with the figures projected in your business plan budget allows you to identify any discrepancies and make necessary adjustments to your budget and spending. This ongoing evaluation ensures that you have a clear understanding of your financial position and enables you to make informed decisions to maintain a healthy cash flow.
When starting out, it is prudent to keep your fixed costs, such as rent, as low as possible. By doing so, you can allocate a significant portion of your funds and initial profits towards establishing a steady cash flow. Remember, cash flow is king as it fuels the growth of your business.
While some start-ups may have access to cash reserves that allow them to sustain planned losses, most start-ups cannot afford to start in this manner. It is wise to maintain a solid cash reserve to safeguard against potential unplanned losses that could otherwise jeopardize the sustainability of your business.
Running out of cash is one of the leading causes of new business failures. Avoid becoming a part of this unfortunate statistic by diligently managing your cash flow. Treat it as a vital lifeline, closely monitoring and controlling your financial resources. By doing so, you will enhance your chances of long-term success and secure the stability of your business.
Remember, your business’s financial well-being depends on maintaining a strong cash flow. Take charge of your budget, monitor your expenses, and keep a close eye on your cash flow to ensure the continued growth and success of your venture.
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Fun Fact!
82% of businesses fail due to inconsistent or insufficient cash flow.
smallbizgenius.net, 2021
Expert Entrepreneur Advice
It is crucial to understand the distinction between net income and cash flow. Many entrepreneurs and small business owners mistakenly equate these two concepts, but they are fundamentally different.
Net income, also known as profit, represents the amount of money a business earns after deducting all costs, allowances, and taxes from its revenue. It is a key indicator of the business’s financial performance and is typically reported on financial statements.
On the other hand, cash flow refers to the actual movement of money in and out of a business. It tracks the inflow and outflow of cash and provides a clear picture of the liquidity and financial health of the business. Cash flow is influenced by factors such as accounts payable (bills you owe) and accounts receivable (payments you are due), which impact the timing and availability of cash within the business.
While net income is an important measure of profitability, it does not necessarily reflect the cash position of the business. A business can be profitable on paper but still experience cash flow challenges if there are delays in receiving payments from customers or if there are significant upfront expenses.
Understanding and managing both net income and cash flow are vital for the financial success of your business. Monitoring your cash flow ensures that you have enough liquidity to cover expenses, repay debts, and invest in growth opportunities. It helps you identify potential cash flow gaps, allowing you to take proactive measures to mitigate them, such as negotiating favorable payment terms with suppliers or implementing effective cash management strategies.
By recognizing the distinction between net income and cash flow, you can make informed financial decisions and develop strategies to optimize both aspects of your business’s financial performance. This knowledge empowers you to maintain a healthy balance between profitability and liquidity, ultimately contributing to the long-term success and sustainability of your business.
Running at a loss
While maintaining a healthy cash flow is essential for most start-ups, there are cases where companies deliberately operate at a loss, especially in certain industries such as technology. This approach challenges the traditional notion of focusing solely on short-term profitability. Examples like Amazon and Tesla demonstrate that some businesses prioritize long-term growth and market dominance over immediate profitability.
In these cases, high net worth investors often play a crucial role. These investors, recognizing the potential of the business and its ability to disrupt markets, provide the necessary financial support to cover the losses incurred during the early years. They have a long-term perspective and believe in the future success and profitability of the company. This approach allows the business to continue investing in growth initiatives, research and development, and market expansion, even if it means operating at a loss in the short term.
However, it is important to note that such a strategy is not applicable to all start-ups. Most new businesses seeking external funding, whether from banks or investors, will typically need to demonstrate a proven track record of profitability before attracting capital. Traditional financial institutions and investors often require evidence of sustainable profitability as a measure of the business’s ability to generate returns and manage risks.
The decision to run at a loss or prioritize profitability depends on various factors, including the nature of the industry, the competitive landscape, the availability of investors willing to support the business, and the overall strategic vision. It is crucial for entrepreneurs to carefully assess their business model, market conditions, and investor expectations to determine the appropriate approach for their specific circumstances.
While running at a loss can be a valid strategy in certain cases, it is essential to maintain a clear understanding of the financial implications and risks involved. Proper financial management, including close monitoring of cash flow, cost control measures, and ongoing evaluation of the business’s growth trajectory, is crucial to ensure that the business remains financially sustainable and can ultimately transition to a profitable state.
Need to knows...
- Burn rate measures how fast a new business uses its capital before making a profit.
- Financial deficit is a loss. It occurs when costs exceed the money coming into a business.
- Financial surplus is the same as profit, which occurs when income exceeds business expenses.
- Liquidity is the ability to turn earnings to cash.
- Net worth can be calculated by deducting the total liabilities of a business from its total assets.
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To fuel and grow your business, you need to have a continuous positive cash flow. This is generated by sales and is supported by careful accounting and financial management. Also make sure that you have contingency funds in place for emergencies.
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Keeping some funds in an emergency savings account ensures that your business will survive a crisis – like COVID-19.
How to improve cash flow
However good you are at generating new sales, maintaining cash flow should be your priority, since it enables you to pay your rent and wage bill at the end of each month.
Ensuring that your cash flows into your business promptly and only goes out as necessary will determine the survival of your start-up. There are several ways of doing this, including invoicing immediately and chasing late payments very strictly. At times, it may help to sell goods at a discount, to run special offers or to find ways to reduce your business or supply costs.
An accurate monthly cash flow statement, reporting the actual inflow and outflow of money, enables you to monitor the situation and decide which steps to take.
1. Keep cash flowing in
Depending on the nature of your business, one or more of these steps may help to maintain your cash flow.
- Invoice immediately, as soon as work is complete, to avoid unnecessary payment delays, or ask customers to pay a deposit or the full price up front.
- Chase late payments, setting up a process to ensure that no payments are missed. Consider offering future discounts for early payments.
- Generate cash by selling items of otherwise “slow-selling” stock at large discounts.
- Increase sales by improving sales techniques or optimising your sales funnel, at worst you can also lower prices or offer discounts to encourage purchases.
2. Managing cash flow out
Spreading your business’s cost (both fixed and variable) can help smooth your cash flow.
- Use a company credit card to defer business costs and possibly earn rewards on what you spend.
- Pay suppliers on your terms, such as within 30 days, to keep cash in your account for longer.
- Review regular costs, exploring other suppliers to find better terms, and seek one-off discounted offers.
- Limit the stock you hold by using accurate sales forecasts, and use suppliers who deliver quickly.
- Improve inventory turnover ratio by increasing demand for your inventory with better marketing or more effective pricing. (See equation below)
