One of the biggest challenges for those running a small business and who do not have a strong background in bookkeeping or accounting that they don’t understand the difference between cash flow and profit. Many promising sole trader businesses have run into trouble because the owners started using the business bank account as their personal ATM, falsely believing that the money left at the end of the month was profit they could use for their own pleasure.
Cash flow is just that – the flow of money coming into the business from revenue and going out to cover expenses. If this is not carefully managed, there may not be enough money available to pay business accounts as they become due. Regardless of how much profit the business is making, if there are no funds to pay the bills, suppliers may refuse to continue supplying essential stock to satisfy customers, and banks or lenders may withhold funds.
Careful management of the business finances is the best way to ensure this does not happen. To do this, owners must understand the variables that impact on cash flow. Customer and supplier terms, the timing of loan payments, future business decisions and many other factors affect cash flow, but by planning and monitoring it, owners can predict shortfalls and surpluses, and make financial decisions accordingly.
One way to do this is to prepare an annual cash flow forecast or statement wherein the owner estimates and records several important parameters. These include the total monthly cash inflow, the total monthly cash outflow, the net cash flow and the opening and closing balances. The cash inflow should include income such as sales, capital injections from borrowings or owner funds, interest revenue or any other sources. Cash outflow would include purchases, loan payments, supplies and expenses such as telephone, electricity, wages and the like.
Bearing in mind that this is only an estimate, the next step is to monitor the inflows and outflows monthly and compare them with the actual figures which, by now, should be available. If the business is not tracking as planned, then the figures need to be reviewed and adjusted throughout the year.
Management may need to look at their stock control to save money on storing and insuring stock they do not need. Careful management of debtors, following up on outstanding accounts and establishing a sound credit policy are all a necessary part of good business management that will support the cash flow forecast. A review of product pricing, improved customer service and a renewed marketing push are all ways to increase income. Reviewing overheads and looking for ways to reduce costs such as power and water bills will also improve cash flow.
The skills of an experienced accountant are often the best investment a business owner can make, especially if handling the financial side is a new experience. Many owners are juggling the demands of running a business as well as the management of their SMSF (self-managed superannuation fund). By using the services of a company such as SMSF Assure to assist with the administration of their SMSF, they will have more time to spend with their accountant on improving aspects of their business such as the cash flow.