One of the main reasons small businesses collapse is they have a poor cash flow strategy. The most common reason for this is that many small business owners do not have a grasp on basic accounting principles. You should learn the basics to maximize your cash flow.
You can either keep cash on hand or in a business bank account in order to take care of the expenses. This will be enough to allow the company to pay bills, to supply investment capital and to have sufficient funds in case of emergencies.
An operating cycle begins with the buying of inventory, and ends with receiving the payment for the inventory. It keeps track of the transition of assets to cash. Normally, you purchase an excess of inventory so as not to exhaust your stock as soon as sales are made. Accounts receivable and cash sales will make up your sales. The normal payment date for accounts receivable is 30 days from the purchase date, which is applicable to both your inventory and products sold. Cash and accounts payable are lessened with an inventory payment is made. The collection of receivables will raise your cash. At this point, the operating cycle and the cash has made a full circle and will start again.
An analysis of the cash flow will demonstrate if the everyday operations produce sufficient cash to reach the obligation and the relation between large expenditures to pay for obligations and large inflows of cash from sales. With this information, it will be apparent if the inflows and outflows of your business have a positive cash flow or a net loss. Over time, important changes will be seen.
A projection of the monthly cash flow will uncover and eliminate any deficiencies or surpluses in the cash flow and show the relations between previous projections and actual figures. A business financial strategy should be changed to allow for more cash when cash deficiencies are discovered. If a surplus of cash is found, it may be due to excessive borrowing or money that should be invested. The purpose is to construct a strategy to allow a well-balanced cash flow.
There are several options for increasing cash reserves:
- Accounts receivables: Properly control your accounts receivables and retrieve overdue accounts as quickly as possible. If you are not aggressive with collection, profits are lost.
- Having stricter credit standards: With the tightening of credit and terms, more clients are paying for their purchases in cash, which leads to more cash on hand and lowering the bad-debt expense. Although this is beneficial in the short term, it may not be as appealing in the long term. Less strict credit policies permit more clients to purchase the products or services.
- Take advantage of the market: A common problem is many small business price their products lower than the market and do not make a profit. You should research the product’s market, distribution costs and the competition before deciding on prices. Constantly keep an eye on the aspects that play a role on pricing and make adjustment when necessary.
- Make use of short-term loans: Taking a loan from a financial institution can solve short-term cash flow problems. The common forms of credit used in these circumstances are revolving credit lines and equity loans.
- Boost sales: One way to increase the cash flow is to boost sales. Take into account, when a large amount of your sales are credit sales, sales are boosted (as well as accounts receivable), but not cash on hand. This causes your inventory to diminish. Due to receivables not being collected until 30 days after the sale, a significant increase in credit sales will diminish the company’s cash reserves fast.
It is important to have sufficient cash on hand to pay for expenses and emergencies. Cash beyond this should be put in a manageable, low-risk, interest bearing account, like a savings account, Treasury bill or short-term certificate of deposit.
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