The Number 1 Thing You Need to Know About Your Business
When you own a small business, it’s vital you understand how money flows into and out of it. At a basic level, you need to know where your income comes from and what your expenses are. At a deeper level, knowing how money moves through your business. This will help you make strategic decisions about growth, invoicing, and debt management. The consequences of not understanding money can be drastic – poor financial management is one of the main reasons businesses fail.
That’s why you need to understand cash flow.
1. What is cash flow?
Before you can start to understand your cash flow, you need to know what cash flow is. Cash flow refers to the movement of money into and out of your business. It’s understanding two things:
- How much money is coming into your business. (Income, loans and transfers of personal money into the business)
- How much is leaving your business. (Expenses, taxes, and loan payments)
2. How do I conduct a cash flow analysis?
Some accounting software programs allow you to conduct a cash flow analysis through the platform itself or via an addon. Open the program and a cash flow statement might be under a “Reports” tab or something similar. So if you’re already using accounting software, you might have a cash flow statement already!
If you don’t use accounting software, you can conduct the analysis yourself. You can do this easily using a spreadsheet. Here’s how:
Step 1.) Enter the amount of cash your business actually had in the bank at the start of a financial period (say a month).
Step 2.) Add up all the money that came into your business in the month. Include only money that actually came in, not money still owing from clients.
Step 3.) Add this to the cash from the start of the month (in Step 1).
Step 4.) Add up the cash that went out for the month, including rent, cost of goods, fixed costs and loan payments.
Step 5.) Subtract the total in Step 4 from the total in Step 3. This gives you your cash at the end of the month, which is also your starting balance for the next month.
If the cash in your account is lower at the start of each month from the previous month, you have a cash flow problem that requires further analysis.
3. Why is cash flow important?
Not making enough money to cover debts is a major reason small businesses fail. Understanding your cash flow can help you take the steps you need to identify and address issues before they threaten your business.
A cash flow analysis can tell you if you’re allowing clients too long to pay their invoices, making you financially vulnerable. You can then determine if you need to charge a deposit for your services or shorten the payment terms. It can also tell you if you’re spending too much in areas that are not profitable for you. This can help you figure out where you need to cut back on spending—or charge your customers more.
Regular cash flow analysis can also show you what times of the year your business drops off – such as if you have a seasonal business. That can help you plan for those times to make sure you have enough money to cover a loss in revenue.
Your business’ survival depends on you understanding your cash flow. You also need to be able to make strategic decisions about your company’s future. Business owners who don’t understand or ignore the importance of cash flow and can lose their business.
As a business owner you need to understand your cash flow and make strategic decisions about your company’s future. Many small business owners make the mistake of not understanding or, even worse, ignoring the importance of cash flow. Don’t let this be you.
If you want to learn the tricks of getting your cashflow working and where and how GST fits in, email Jamie Tulloch for some free tips.