What is Cash Flow and Why Is It Important?
Now that you’re doing a budget, reconciling your bank accounts, and looking at your numbers each month, it’s time to discuss cash flow.
Cash flow is the movement of cash in and out of your business. It is not sales and expenses.
If you contract with a customer to sell them $50,000 worth of widgets, your sales just increased by $50,000! But this is only a promise from them. How much did your bank account increase? None. Zip. Zilch. Nada. Can you use that $50,000 to pay your suppliers the $30,000 it cost to make those widgets? No. At least, not yet. Not until the customer pays you.
Now let’s look at the somewhat opposite scenario. Say your customer pays you the $50,000 and your bank account does, indeed, go up by $50,000. For your next project, you pay suppliers $20,000 to produce thingamajigs. But this time, you only sell $15,000 worth of thingamajigs. This project has a $5,000 loss. But do you have cash in the bank to pay your suppliers? Yes! Can you cover this $5,000 loss? Yes! The project is still not profitable, but you did not run out of cash because you had enough left over from the widget project to cover it.
This is why cash flow is so important. With enough cash coming in, your business can handle a few bumps in the road. You can pay your suppliers and your employees. You won’t have to buy things on credit or take out loans.
So how much cash should you keep on hand? That brings us to the emergency fund.
In business, the “emergency fund” is also known as “cash reserves.” According to Dave Ramsey, every business should have 3-6 months of expenses set aside as cash reserves. This money should be in a bank account that is relatively easy to access, but not as easy as the business’s checking account. It is used to cover any expenses for a month where sales alone aren’t enough. So the next time you have a project that doesn’t go as planned, you can use your cash reserves to keep your company afloat.
Do you need help with making all the financial parts of your business work for you? Contact me today and we can discuss how I can help you thrive.