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 large gap 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 bankruptcy because 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. Invoicing is 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 negative cash balance for the year is:
Acme, Inc. Cash Flow Statement for the Year Ended Dec. 31, 2021
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 as debt financing or 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 or collateral for 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 money invested 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. 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.
