The Three Most Important Aspects of Small Business Cash Flow
Last week we discussed two very important financial statements. This week, we are going to take a look at an equally valuable statement, cash flow. Small business cash flow, or the lack of it, is what most often causes a small business to fail. It’s easy to believe that if revenue is up, that your cash level will be, too, but that’s not always what happens. On your balance sheet, remember that assets equal your liabilities and owner’s equity. As any one balance sheet item changes, another element must change to keep the balance sheet balanced. Remember these basic rules (assuming no other changes occur):
- In order for cash to increase, some other asset must decrease.
- Cash levels will decrease if another asset increases, such as inventory or receivables.
- If your liabilities increase, cash will also increase. If you pay down your debts (liabilities decrease), your cash levels will decrease.
Looking at specific balance sheet items, here are the top three items you must watch to keep your cash position strong:
- Inventory. Increased inventory levels may cause a decrease in cash levels or an increase in accounts payable; either way, an increase in inventory that doesn’t turn quickly will cause a decrease in cash.
- Accounts Receivable. Increased sales may become an increase in customer balances due you (Accounts Receivable). You’ve paid for inventory or payroll but haven’t yet received cash from your customers, which causes a decrease in cash levels. In a desire to increase sales, be careful not to unusually extend credit; this can cause a cash crunch not easily resolved.
Inventory levels and customer receivables often grow as sales increase; cash levels can decrease quickly if you don’t keep a close eye on them all.
- Accounts Payable. Slowing down payments to vendors can help cash in the short term, until vendors demand cash on delivery. You then are paying for new stock without having paid for inventory on hand. Be careful not to build inventory levels for which you don’t have the cash to pay for.
Don’t let this basic financial statement, your Statement of Cash Flow, confuse or overwhelm you. This is basic math: as any asset or liability changes, another item, such as cash, must also change. As revenues increase, watch your inventory, receivables and payables especially and cash will remain strong.
Tags: Business Finances