Cash Flow Management in Business (2024)

  • Building Your Business
  • Accounting

By

Susan Ward

Cash Flow Management in Business (1)

Susan Ward

Susan Ward wrote about small businesses for The Balance for 18 years. She has run an IT consulting firm and designed and presented courses on how to promote small businesses.

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Updated on September 19, 2022

Fact checked by

Daniel Rathburn

Cash Flow Management in Business (2)

Fact checked byDaniel Rathburn

Daniel Rathburn is an associate editor at The Balance. He has over three years of experience working in print and digital media as a fact-checker and editor. Daniel holds a bachelor's degree in English and political science from Michigan State University.

In This Article

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In This Article

  • Importance of Cash Flow Management
  • Examples of Cash Flow Management Problems in Business
  • Acme, Inc. Cash Flow Statement for the Year Ended Dec. 31, 2021
  • Solving Cash Flow Problems
  • Debt Financing vs. Equity Financing
  • Frequently Asked Questions (FAQs)

Cash Flow Management in Business (3)

The definition of cash flow managementfor business can be summarized asthe process of monitoring, analyzing, and optimizing the net amount of cash receipts minus cash expenses. Net cash flowis an important measure of financial health for any business.

Key Takeaways

  • Cash flow management is perhaps the most important facet of running a small business.
  • Extended cash shortages, which occur when there's a large gap between cash inflows and outflows is a common reason why businesses fail.
  • Many accounting softwares have cash flow management built into it.
  • One strategy to improve cash flow management is to shorten the conversion period.

Importance of Cash Flow Management

One of the most common reasons cited as why businesses fail is poor cash flow management. If your business constantly spends more than it earns, you have a cash flow problem.

For small businesses, the most important aspect of cash flow management is avoiding extended cash shortages, caused by an overly largegap between cash inflows and outflows. You won't be able to stay in business if you can't pay your bills for an extended period of time.

Examples of Cash Flow Management Problems in Business

Real estate development has always been a highly cyclical industry, and developers are often prone to cash flow problems. Property development requires significant initial capital investment, as well as ongoing cash outflows for operations.

Unless some or all of the development can be sold before construction, developers often run into cash flow problems before the development begins to sell off, particularly if the property market happens to soften during construction. Many property developers have been forced into bankruptcybecause of negative cash flow for extended periods of time.

Any business that's undergoing rapid expansion can run into cash flow problems as well. Business expansion generally involves higher labor costs as new employees are hired, higher rent for additional space, higher advertising costs, and more capital investment for new facilities, equipment, and so on. Having to maintain increased levels of inventory can also eat into excess cash.

Extending credit to other businesses is another common way for businesses to run into cash flow problems. Invoicingis normally done on 30- or 60-day terms, and it isn't unusual for customers to delay payment, which can leave a business in a cash flow crunch. An example of a business with cash flow management problems and a negativecash balance for the year is:

Acme, Inc.Cash Flow Statement for the Year Ended Dec. 31, 2021

Cash Flow From Operations$
Receipts
Customer Invoices$80,500
Other$1,500
Disbursem*nts
Employee Salaries-$45,000
Suppliers-$25,500
Other-$5,000
Net Cash Flow From Operations$6,500
Cash Flow From Investments
Equipment and Software Purchases-$5,500
Net Cash Flow From Investments-$5,500
Cash Flow From Financing
Loan Payments-$3,300
Shareholder Dividends-$5,000
Net Cash Flow From Financing-$8,300
Net Change in Cash Balance-$7,300

Solving Cash Flow Problems

As a business owner, you need to perform a cash flow analysis on a regular basisand use cash flow forecasting so you can take the steps necessary to head off cash flow problems.Many software accounting programs have built-in reporting features that make cash flow analysis easy.This is thefirst step in cash flow management.

The second step of cash flow management is to develop and use strategies that will maintain adequate cash flow for your business. One of the most useful strategies for your small business is to shorten the cash flow conversion period so that your business can bring in money faster.

If your business is expanding, you may need one or more injections of cash during the growth phase. This can take the form of a business loan from a financial institution known asdebt financingor equity financing from investors.

Debt Financing vs.Equity Financing

Debt financing is common for assets, such as equipment, buildings, land, or machinery, when the assets to be purchased are used as security orcollateralfor the loan. The main advantage of debt financing over equity financing is that the business owner doesn't have to give up partial ownership of the business and thus can retain full control. For short-term cash flow shortages, many small business owners make use of credit cards or lines of credit.

Equity financing involves raising money from angel investors or venture capitalists. Equity financing is much less risky because moneyinvested doesn't have to be repaid if the business doesn't succeed. However, in exchange for financing, the investor becomes a part owner and, as such, takes a share of the profits and has a say in how the business is run.

Whatever form of financing is required, it's vital to have an updated business plan in place to present to financial institutions or investors. The business plan should demonstrate the need (and effect) of financing for the future of the business.

Frequently Asked Questions (FAQs)

How do you solve cash flow problems?

The first step to managing your cash flow is running regular cash flow analyses. You should

review the credit history of your customers and stay on top of business indicators such as recurring busy or slow periods to ensure your business can manage inflows and outflows properly.

What's the difference between debt financing and equity financing?

If a company uses debt financing, it is borrowing money from a firm and will pay interest for doing so. In equity financing, a business' owners sell a portion of the organization in exchange for extra working capital.

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I'm an expert in business and finance with a deep understanding of cash flow management, having actively worked in the field and dealt with various aspects of running a business. My expertise extends to financial analysis, accounting, and strategic planning to ensure the financial health of a company.

Now, let's delve into the concepts presented in the article about building your business accounting by Susan Ward on The Balance. The article highlights the importance of cash flow management and provides insights into common problems businesses face in this regard. Here's a breakdown of the key concepts:

  1. Importance of Cash Flow Management:

    • Cash flow management is crucial for small businesses, with poor management often cited as a common reason for business failure.
    • Extended cash shortages, resulting from a significant gap between cash inflows and outflows, can lead to financial instability.
  2. Examples of Cash Flow Management Problems in Business:

    • Real estate developers, facing cyclical market trends, often struggle with cash flow problems due to substantial initial capital investments and ongoing operational costs.
    • Rapidly expanding businesses may encounter cash flow challenges due to increased labor costs, higher rent, advertising expenses, and additional capital investments.
    • Extending credit to other businesses can lead to cash flow issues, especially when customers delay payments.
  3. Acme, Inc. Cash Flow Statement (Example):

    • Presented a sample cash flow statement for Acme, Inc., indicating cash flows from operations, investments, and financing.
    • The statement highlights the importance of managing cash flows to avoid negative balances and financial distress.
  4. Solving Cash Flow Problems:

    • Business owners should perform regular cash flow analyses and utilize cash flow forecasting to proactively address potential issues.
    • Software accounting programs often include features for easy cash flow analysis.
  5. Debt Financing vs. Equity Financing:

    • Debt financing involves borrowing money for assets, with the advantage of retaining full control without giving up ownership.
    • Equity financing entails raising money from investors, providing less risk but involving shared ownership and profit distribution.
  6. Frequently Asked Questions (FAQs):

    • Explained how to solve cash flow problems through regular analyses and staying informed about customer credit history and business indicators.
    • Highlighted the difference between debt financing and equity financing.

The article emphasizes the need for a proactive approach to cash flow management, using tools like cash flow analyses and forecasting, and considering financing options wisely to ensure the long-term financial health of a business.

Cash Flow Management in Business (2024)

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