You’re making sales. Your bookkeeper says the business is profitable. But you’re having trouble paying expenses and bills on time. Why is that?

It’s called a lack of cash. The harsh truth is that just because a business is making a profit doesn’t mean that your bank account is awash with cash. Running out of money is a major reason that small businesses fail—even profitable ones.

If you want to avoid becoming another business casualty, follow these tips to maintain a positive cash flow.

Cash Flow-Positive vs. Profitability

Let’s start by making clear the difference between cash flow and profits.

Suppose you make a $1,000 sale to a customer and send an invoice that is due in 30 days. The cost of goods sold for this sale is $400 for direct labor and $300 for materials.

Your bookkeeper records the sale of $1,000 into accounts receivable and charges $700 to labor and materials accounts. These accounting entries create a gross profit of $300. Everything is okay so far.

But what about the cash flow?

Your supplier may have given you 30-day terms on the materials, but labor wages are usually paid weekly. Not only that, your bookkeeper could have paid a few overhead expenses such as rent, insurance premiums and office wages. The result is you’ve got more cash going out than coming in since your customer hasn’t paid the $1,000 invoice yet.

Now multiply this scenario, say 50 times per month, and the negative cash flow starts to add up. Profits? Yes. But you can see how more cash going out than coming in could become a problem.

This is an example of a profitable business that could begin to have problems paying its bills.

What It Means to Have a Positive Cash Flow

Businesses need to have cash in the bank at all times to cover expenses, buy raw materials or inventory and pay employees. These funds could come from initial equity capital contributions, proceeds of loan advances or cash received from making sales and collecting receivables.

The cash flow problem comes from the difference in timing between paying expenses and receiving sources of capital, as illustrated in the above example. Companies often get into cash flow trouble during periods of strong growth. To support this growth, you need more funds for higher inventory levels and additional staff. If these expenses hit before cash comes in from customer invoices, you have a cash flow problem.

Quite simply, cash flow positive means having more money coming in than going out at any given time. Ironically, even unprofitable companies can have occasional periods of positive cash flow. They can stay in business for long periods of time if they can attract more outside investors or find lenders willing to extend credit to them to make up the cash flow deficits.

What Are the Types of Cash Flow?

Cash flow comes from three sources:

  • Operating transactions – These are the normal activities of a business: collecting receivables, buying materials, paying wages and covering expenses.
  • Investment activities – Purchases and sales of long-term assets are investment activities. These include transactions for property, plant and equipment.
  • Financing – Borrowing money and repaying loans are financing activities.

How to Calculate Your Cash Flow Balance

Follow these steps to determine whether you have a positive or negative cash flow:

  • Start with the amount of cash in your bank at the beginning of the month.
  • Add in the payments received from customers, proceeds from sales of long-term assets and advances from loans.
  • Subtract all expenses paid, any purchases of long-term assets that required cash outlays and repayments of loans.
  • The final figure will be your cash balance in the bank at the end of the month.

If the month-end balance is higher than the balance at the beginning of the month, you have a positive cash flow. If it’s less, your cash flow is negative.

Prepare a Cash Flow Forecast

One of the best ways to manage cash flow is to prepare a forecast so that you don’t get surprised when a deficit happens. If your forecast shows potential cash flow problems ahead, you can take steps in advance to minimize or eliminate them before they become a crisis.

Let’s say you have a seasonal business, and for a few months, inbound cash flow is strong. But during the slow months, cash goes out like a river. You can prepare for these negative conditions by building up your cash reserves or making arrangements in advance with a lender for a loan to cover the deficits.

cash flow analysis

Tips to Manage and Generate Positive Cash Flow

1. Send out invoices immediately.

Don’t wait until the end of the month or even the end of a week. Customers will not pay until you send them an invoice. It’s that simple. If your invoicing process is laborious, consider purchasing accounting software with invoicing capabilities.

2. Encourage customers to pay on time by sending out email reminders.

Just be careful not to overdo this approach; it can become annoying to customers with good paying habits.

3. Offer customers an incentive to pay sooner.

A 2% discount for paying within 10 days of the date of the invoice is a common offer. Another alternative is to set up an invoice factoring agreement with a lender to receive funds sooner.

4. Analyze your inventory.

Look for old inventory that is not selling and offer attractive discounts to move these items. Any cash you receive is better than none.

5. Consider a lease.

Leases usually require smaller down payments than loans. Go over your expenses. Costs can sometimes slip out of control if you’re not paying attention. Do you have more employees than needed? Are they working overtime? Has your inventory level gone up too much?

6. Negotiate with suppliers.

If you keep close contacts with your suppliers, you will have a better chance of receiving lower prices from them. As with your own customers, offer suppliers early payments in exchange for discounts on prices.

7. Watch for estimated tax payments.

Let’s face it, you’re probably more interested in paying your suppliers than the government. But quarterly tax payments can creep up on you, so don’t ignore them. Put upcoming tax payments in your cash flow forecast and make monthly set-asides so you don’t end up with a large tax bill and not enough money on hand to pay it.

8. Build up a cushion.

The business world is not perfect; cash doesn’t always come in when expected. A good target is to keep a cash balance in your bank for a month’s worth of expenses. This level will usually cover any minor dips in cash flow.

Keeping up with your cash flow will give you an instant feel for the health of the business. Unlike accounting for profits, cash flow balances are unaffected by depreciation methods and entries for accrued expenses or unearned income. You either have more cash in the bank at the end of the month or you don’t.

The good news is you’re in control of your cash flow. You have numerous tools at your disposal to create and maintain a positive cash flow for your business.

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