While reading this excellent article about a guy teaching his son some early business lessons using a soda machine, I got to thinking. No, I wasn’t thinking I should buy my son Adam a soda machine (he’s only 4).
I thought about small business owners and how crucial cash flow is to them. Wikipedia defines cash flow as “the movement of money into or out of a business, project or financial product”. From experience, I also know that many make the mistake of equating profit with cash flow. While related, the two are different. I’ve heard several times “I’m making money on these jobs/sales, but we never seem to have any money.”
For example, Wal-Mart is known for their killer distribution system. They can get products from vendor to warehouse to store shelves so fast, I would guess they might actually sell a lot of the product before they even have to pay their vendors. That is basically the dream scenario when it comes to cash flow - collect the sales revenue before you even have to pay for the cost of that revenue.
But not every company has that power. Take a contractor for example. Due to the nature of the business, they are usually paid some money up front and the balance at the end of the project (perhaps some in the middle if there are multiple steps in the job). Assuming the contractor prices the job to make a profit, his cash flow is still less than ideal, since he will probably incur all the costs of the job – materials, labor, permits, etc. before being paid in full.
So how does he handle this? There are 3 types of cash flow in a business and each of those can certainly help:
- Cash flows from operations – this is cash generated (or used) from normal business activities – selling, collecting accounts receivable, paying accounts payable, etc. In the case of our contractor, he could use cash from previous jobs to foot the costs of the current jobs and so on. In my opinion, this is the best way to run a business.
- Cash flows from investing – this includes cash generated (used) from things like selling (buying) equipment. Usually selling equipment to meet operational costs is not a good idea, since you will probably need that equipment later on.
- Cash flows from financing – this covers cash generated by issuing stock or taking on debt or used by paying dividends, repurchasing stock or paying down debt. Many companies have a line of credit with a lender that can help bridge the gap temporarily. However if it is overused it can lead to trouble.
There are several ways within each of these three types that business owners can manage their cash flow. Next time you sit down and look at your books, don’t stop at your profit & loss (income statement), take a look at your cash flow statement too. It is a good tool to help understand the total picture. Or why even a profitable company may be struggling with cash.
How is your company managing cash? What strategies have you used to improve your cash flow? I’d love your input, either in a comment below or via email.
Thanks for reading.
