Understanding Cash Flow for beginners
Tidy cash flow tracking transforms a good business into a great one.
As stated in my last article this week's content revolves around financials.
👉 Today, Ι will be covering cash flow and presenting you with a comprehensive list of SOS operating expenses that you should monitor and include in your cash flow management.
PS. If you're searching for a comprehensive cash flow template to kickstart your work, you can discover an excellent one here: https://www.score.org/resource/template/financial-projections-template
So, let’s begin!
🔥 Why it is so important to monitor Cash Flow
Well, in plain words, monitoring cash flow is vital for the financial health of a business.
Business owners should have a clear understanding of the timing of cash inflows and outflows to ensure there is enough liquidity to meet financial obligations.
According to the author Greg Crabtree in his book "Simple Numbers, Straight Talk, Big Profits! " understanding and managing cash flow is critical for the financial health and success of a business.
💥 Business owners need to be aware of several key aspects related to cash flow:
Cash Inflows and Outflows: It is essential to have a clear understanding of the timing and sources of cash inflows (money coming into the business) and cash outflows (money going out of the business).
This includes tracking revenue from sales, collections from customers, loans, and any other sources of incoming cash, as well as monitoring expenses, loan payments, and other cash outflows.
Cash Flow Forecasting: Forecasting future cash flows is vital for planning and decision-making.
Business owners should create cash flow projections to anticipate periods of cash surplus or deficit, helping them make informed decisions about investments, expenses, and financing.
Cash Reserves: Maintaining adequate cash reserves or a cash cushion is crucial for handling unexpected expenses or economic downturns. Having enough cash on hand provides financial security and reduces the reliance on external financing during challenging times.
Managing Accounts Receivable and Payable: Monitoring accounts receivable (outstanding customer payments) and accounts payable (outstanding bills to suppliers) is essential for cash flow management.
Collecting receivables promptly and negotiating favorable payment terms with suppliers can improve cash flow.
Capital Expenditures: Analyzing capital expenditures (large investments in assets like equipment or property) and their timing is essential for managing cash flow. Business owners should assess the impact of such investments on cash reserves and the expected return on investment.
Contingency Planning: Creating contingency plans for potential cash flow disruptions, such as late-paying customers or unexpected expenses, helps business owners respond swiftly and effectively to adverse situations.
Profit vs. Cash Flow: Understanding the difference between profit and cash flow is crucial.
While a business may be profitable on paper, it's essential to ensure that sufficient cash is available to cover operating expenses and other financial obligations.
Financing Options: When cash flow is tight, exploring appropriate financing options (such as lines of credit or short-term loans) can provide additional liquidity to meet cash needs.
By being aware of these aspects and actively managing cash flow, business owners can enhance their company's financial stability, make well-informed decisions, and position the business for long-term success.
Proper cash flow management is a fundamental element of financial planning and plays a significant role in achieving sustainable profitability.
Example Cash Flow Statement - June 2023:
Cash Inflows:
Cash Sales: 30,000 euros
Collections from Accounts Receivable: 25,000 euros
Loan from Bank: 10,000 euros
Total Cash Inflows: 65,000 euros
Cash Outflows:
Rent: 5,000 euros
Salaries and Wages: 20,000 euros
Utilities (Electricity, Water, Internet): 2,500 euros
Office Supplies: 1,000 euros
Inventory Purchases: 15,000 euros
Loan Repayment: 2,000 euros
Marketing and Advertising Expenses: 3,500 euros
Total Cash Outflows: 49,000 euros
Net Cash Flow (Cash Inflows - Cash Outflows):
Net Cash Flow = 65,000 - 49,000 = 16,000 euros
Cash at the Beginning of the Month: 10,000 euros
Cash at the End of the Month (Cash at the Beginning + Net Cash Flow):
Cash at the End of the Month = 10,000 + 16,000 = 26,000 euros
Summary:
In this example, the total cash inflows for the month of June amounted to 65,000 euros, which includes cash sales, collections from accounts receivable, and a loan from the bank. The total cash outflows for the month were 49,000 euros, covering various expenses, inventory purchases, loan repayment, and marketing costs.
The net cash flow for the month is calculated by subtracting the total cash outflows from the total cash inflows: 65,000 - 49,000 = 16,000 euros.
At the beginning of June, the company had 10,000 euros in cash. Considering the net cash flow for the month, the company ends July with 26,000 euros in cash.
This cash flow statement provides a snapshot of the company's cash position for the month of June, showing the inflow and outflow of cash and the resulting cash balance.
Business owners use such statements to monitor and manage cash flow, ensuring sufficient liquidity to meet financial obligations and make strategic decisions.
Operating Expenses
Knowing the breakdown of operating expenses is essential for identifying areas where cost control or optimization is needed. Understanding these expenses allows business owners to make informed decisions to improve profitability.
In general accounting and financial management, operating expenses refer to the regular and ongoing expenses a business incurs to maintain its daily operations. These expenses are distinct from the cost of goods sold (COGS), which are directly associated with producing goods or delivering services.
👉 Operating expenses typically include, but are not limited to:
Salaries and Wages: The compensation paid to employees for their services.
Rent and Utilities: The cost of leasing or owning the business premises, as well as utilities such as electricity, water, and internet.
Office Supplies: Expenses for office consumables like paper, pens, ink cartridges, etc.
Insurance: Premiums for various insurance policies, such as liability insurance, property insurance, or health insurance for employees.
Marketing and Advertising: Expenditures for promoting the business and its products or services.
Maintenance and Repairs: Costs associated with maintaining and repairing equipment, machinery, or property.
Travel and Entertainment: Expenses related to business travel, meals, and entertainment for clients or employees.
Professional Fees: Fees paid to consultants, accountants, lawyers, or other professional services.
Depreciation and Amortization: The allocation of the cost of tangible assets (depreciation) or intangible assets (amortization) over their useful lives.
Taxes and Licenses: Various taxes, such as property tax, sales tax, and licenses required to operate the business legally.
Please note that this list is not exhaustive, and the specific operating expenses for a particular business may vary based on its industry, size, and operational model.
As entrepreneurs, we often embody the doers, the ones who roll up our sleeves and handle the front-line tasks.
🌱 However, if our aspirations include scaling the business and establishing a prosperous company, it is essential to dedicate sufficient time to manage cash flow, assess financial performance, and devise strategies to optimize profits.
Speaking of strategies, be sure to tune in next week when I will share valuable insights strategies a business owner can implement to boost employee productivity and manage labor costs (+ and delve into the significance of these terms in detail).
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Very well said Souzana! Cash flow management is vital for the company's sustainability and growth!