What’s the single most important thing to run a business?
The answer is *drumrolls* Money! Lots and lots of it!
There’s no business without money and we are already aware of it. But have you ever wondered why most businesses tank within the first five years of their existence even after having some of the most promising products & investors backing them up?
According to a study by US Bank, 82% of businesses fail due to improper cash flow management. (Source: Business Insider)
Thus, in this blog, we have attempted to explain cash flow including every striking detail!
What is Cash Flow Management?
It is said that the secret to a business’s success or failure lies in its cash flow statement.
But what is cash flow and why is it so crucial for businesses? Let’s understand.
As individuals, we all maintain excel sheets or use an app to keep a record of our monthly expenses & income. That’s exactly what we refer to as “cash flow”. It’s all the money that’s earned & all the money that’s spent in any given period of time.
In terms of businesses, the description of cash flow is a bit more complex as business income & expenditure are a combination of elements.
Cash flow management refers to the practice of tracking how much cash is coming in and going out of a business.
To efficiently manage the cash flow, you need to clearly understand every single element of it in detail. Ahead are some of the crucial terminology & factors related to small business cash flow management that every business owner needs to know:
Positive Cash Flow & Negative Cash Flow
Cash flow can be further identified as positive or negative. Positive cash flow is when a business makes more money than its total expenditure. The money remaining after subtracting the expenditure from income is called profit. So when a business is making a profit, it is said to have a positive cash flow or healthy cash flow.
Negative cash flow is when a company spends more than it earns. In a negative cash flow situation, a company struggles to pay dividends to its shareholders, fulfill their financial obligations & repay their loans. It is called an unhealthy cash flow situation as businesses fail to fulfill their regular commitments due to a cash crunch. If this situation continues to prevail, there’s a high chance that a company will go out of business.
Emergency Funds: To avoid the situation of a cash crunch, businesses are suggested to set aside an amount of money as emergency funds. Businesses can use this emergency fund during a negative cash flow situation to fulfill their financial obligations and stay afloat during the difficult phases.
As we have already discussed, the cash in a business comes from various sources & activities. Here are some types of cash flow that we usually see in a cash flow statement:
Types of Cash Flow
While analysing a business’s cash flow, it is important to consider where the cash is coming from. For example, a company’s capital gains can be a result of increased sales or a loan or borrowing. Therefore, a company’s cash flow is divided into four categories: operational cash flow, investment cash flow, financing cash flow, and free cash flow.
Operational Cash Flow
Operational cash flow refers to money that flows in or out of the business due to major business operations like manufacturing, sales, distribution, etc. For example, if a company ABC sells furniture. All the cash from manufacturing, promotion, sales & distribution of the furniture comes under operational cash flow. This is the fundamental measure of money that a business has made through its operations & reflects the company’s operating profits.
A growing CFO (cash from operations) is an indicator of a growing business while a declining CFO represents a shrinking business.
Investment Cash Flow
This refers to the cash spent and made through investment activities. It involves the purchase or sales of any long term asset such as a building, machinery, plant, infrastructure, etc. It is essentially any money that is spent to grow the business & streamline the operations in the long run.
Cash flow from CFI (cash from investing activities) is usually negative as a company is usually spending cash to grow or maintain its business. However, in some cases, the CFI can be positive when a company’s assets start generating revenue or when a company decides to sell its assets.
Finance Cash Flow
This refers to cash spent or received through financing activities such as issuing shares or bonds, taking long-term loans, expenditure on repurchasing stocks, debt repayments, etc.
A positive CFF (cash from financing) indicates that the company is raising money to grow its business or meet its financial obligations. On the other hand, a negative CFF suggests that the company is paying out money to repay a loan, or paying shareholders as dividends, etc.
When you net all these three cash flows, you get the company’s net change in cash. The net change in cash represents how an organization’s cash balance changes in a given year due to various factors.
Free Cash Flow
Even though it is not a part of the three major cash flow categories, it is still doted on by the investors. Free cash is the remaining amount that the company is left with after subtracting capital expenditures from the operating cash flow. It gets its name from the fact that free cash flow is free from any commitments or financial obligations. Business analysts often use free cash flow as a measure to estimate the profitability of a business.
Cash Flow Statement
A cash flow statement is a document that assesses how a company handles its cash. The statement records a detail about the company’s cash inflow & outflow under all four streams; operations, investments, financing & free cash flow.
The cash flow statement of a company is an important document for the value investors & shareholders to assess the actual position of a firm in the market.
Even though net income is considered to be a vital factor to showcase a company’s wealth, investors trust cash flow as it gives a more comprehensive picture of the quality of a firm’s earnings and throws ample light on how sustainable they are!
Even after having the same earnings, two businesses can have completely different financial conditions depending on their cash flow. For example, company A & company B both have registered the same earning of $ 10 million in a given financial year. However, upon looking at their cash flow statements, it is possible that company A has higher cash from operations while company B has higher cash from financing, which means company B has registered the same earnings after taking a debt.
To further understand cash flow simply, let’s have a look at Robert Kiyosaki’s infamous Cash Flow Quadrant:
Cash Flow Quadrant by Robert Kiyosaki (Author: Rich Dad, Poor Dad)
In his best-seller, Rich Dad, Poor Dad, author Robert Kiyosaki described the Cash Flow Quadrant, a conceptual tool depicting cash flow from various streams.
According to Mr Kiyosaki, there are four types of people; Employees, Self-Employed/Small Business Owners, Business Owners & Investors.
Employees spend their lifetime in a job that provides a stable income. In his book, Kiyosaki writes that his poor father always encouraged him to study & get a job. Even though there’s nothing wrong with being an employee, the tax liabilities are the highest for employees.
Specialists or small business owners refer to individuals with specialized skills like doctors, chartered accountants, or any small business owners.
The third category is business owners or entrepreneurs and the fourth category is investors. According to Kiyosaki, his rich dad encouraged him to become an entrepreneur & investor as the third and the fourth categories are where the real wealth is built.
Even though anyone in these four categories can be rich. However, it makes more sense to work hard towards something you own. For the business owners to make more money & grow their business, it is crucial to keep a track of where the money is coming from & where they are spending it.
Robert Kiyosaki’s cash flow quadrant is a simple tool to understand where the money lies & how it can be attained.
It is advised that businesses must invest in assets, something that can generate revenue like mutual funds investments, real estate investments, etc., instead of spending their money on liabilities.
Monitor, Analyze And Optimize Your Cash Flow With Shootih
For small businesses to better analyze their cash and eventually grow into bigger businesses & value investors, cash flow management is crucial. Shootih is a smart AI-based cash flow management tool that allows businesses to efficiently manage, track & analyze their cash flow.
With Shootih, you can:
- Get an aggregated view of your multiple bank accounts on a single dashboard.
- Easily forecast expenses and revenue.
- Get immediate notifications for any unexpected bills, overdue payments, or out-of-cash predictions.
- Get information regarding investing your idle cash over holidays or weekends.
- Invite your financial advisors, CFOs, CA and other team members to collaborate on a single platform to ensure maximum transparency.
To understand how Shootih works, you can book a demo call with us here: https://shootih.com/contact-us/