What is Cash Flow? (Plus Ways to Improve It)
November 22, 2010
“Cash flow is the movement of cash into or out of a business, project, or financial product.”
Great, but what does that mean? From a practical standpoint, it’s the “into or out” of a business. So for your (very) small business, it’s the revenue (invoices) coming in and expenses (utilities, staff, contractors etc.) going out. But that sounds a lot like profit. The difference is that profit is over a set time period (quarter, year etc) while Cash flow is having enough money coming in to cover the money going out at any given time (a set date).
For example, when it comes time to pay your contractors, do you have enough money from paid invoices to pay them? Simply, it’s all about having cash on hand, or access to cash. For example, one backup to organic cash flow (invoices in, expenses out) is a line of credit, or a working capital loan. However, loans cost you more money, so it’s best to keep it organic.
How Do You Improve Your Organic Cashflow?
The best way to improve your cash flow is to shorten your receivables (get paid faster) and extend your payables (pay bills later). Consumer-oriented products and services do this the best as they require payment up front for services or products. For example, Dell.com. When you order from them, they take payment right away so their days of receivables are zero. After payment, they order the required parts from their suppliers on a set payment term, build it, and ship to you. Since they buy products on contract (with terms) from their suppliers, they can delay payment for a while after they have received cash from a consumer. This allows them to have cash coming in before it even goes out.
But how does this work for your service-based business? First, have a schedule of all your due incoming invoices (payment) and outgoing expenses (payout). This way you can predict when you’ll be running lower on cash and can prepare against it. Second, invoice early and often! Have payment schedules built into your contracts, so you can get payment throughout the project, or at least at each deliverable. This will require strong client satisfaction through constant communication with your client, not just a contract. Keep updating them through the project so they’re satisfied and will pay. And lastly, follow up on outstanding invoices – take the time to follow up via email, phone and everything else. It’s worth doing it once a week or month so you can get more cash in the door.
How else do you improve your cash flow?