Understanding Cash Flow: Managing Money Flow in Simple Terms

Learn How to Manage Money Flow with Clear and Concise Insights Effectively. Empower Your Business Finances for Success with Easy-to-Understand Cash Flow Understanding.

What Is Cash Flow, And Why Is It Important For Small Businesses?

Cash flow management lets you forecast expenses, prepare for dry months, and know what to charge your clients. For example, being able to tell if you’ll be bringing in less money in the coming month will allow you to spend and invest your money responsibly.

Accounts receivable versus accounts payable

It’s important to differentiate between accounts receivable and accounts payable. Accounts receivable represent your assets, like a positive bank balance or cash. Management accounts payable rounds up your liabilities, like payments or debts you owe.

The difference between profit and cash flow

Because cash flow only represents the balance in your bank account, your business can turn a profit and still have zero cash. For example, You might earn a 30% profit on every product you sell, but you still have negative cash flow if you have more expenses than income.

Your business could profit $20,000 monthly but only see $8,000 in cash flow because the rest is pending in accounts receivable. That’s why profit and cash flow aren’t interchangeable terms.

Cash flow for small businesses

If you’re thinking about starting a business or recently launching a new one, you’ll need to invest some cash in the early days to get set up. You might need to buy new equipment, pay for a website, or put down a deposit to rent office space. That’s why you shouldn’t be alarmed if you see more money leave your business than come in—at least initially.

Seasonal businesses and cash flow

You’ll see an influx of cash during a specific season and little-to-no cash during the year’s remaining months. Learning cash flow management can help keep your business finances in the black even in your off-season.

These simple steps will get you started in the right direction:

Put together a cash flow statement a little later, and we’ll show you how to generate a cash flow statement. It’s important to understand that putting together a cash flow statement will show all your business transactions (income and expenses).

It generally includes three sections: cash from operations, cash from financing, and cash from investing.

Forecast your expenses

Using your cash flow statement, you can see which months you’ll likely feel the pinch in your cash flow. Once you identify those periods, you can create an expense forecast. You’ll estimate your operational costs for those months, including your rent, payroll, and any other recurring monthly expenses, to see how much you’ll need on hand.

Your expense forecast lets you know exactly how much to set aside for slower periods.

Plan ahead

Whether you’re a seasonal business owner or experience slow sales periods throughout the year, planning can save you time and stress. Here’s where forecasting from the last step comes in.

To prevent problems before they crop up, take those anticipated payments for your slower seasons, figure out which payments you can and can’t delay, and then set aside enough cash from peak sales periods to cover all your operating expenses during the off-season. Also, consider setting aside an extra cash buffer to cover any unexpected costs.

How To Understand, Calculate, And Manage Cash Flow

Whether you’re an established business or a startup, hiring an accountant or bookkeeper may not be financially feasible.

Wave also syncs with your bank accounts, is compatible with other accounting software packages, and gives you access to one of the most important tools you’ll need: a cash flow statement. Cash flow statements shouldn’t be confused with income statements or balance sheets. Each of these is distinct from one another and serves different purposes.

Cash flow statements versus income statements and balance sheets

Income Statement

An income statement shows your business’s financial performance during a given accounting period.

  • Is it overperforming?
  • Underperforming?

These are questions an income statement helps answer.

Cash Flow Statement

Last (but certainly not least), cash flow statements explain how cash moves into and out of your business. Typically, these statements break down cash flow activity into three segments for easier tracking: operating, investing, and financing.

  • Operating Flow: Operating flow refers to any income or spending from your net income. That can include buying merchandise and revenues from selling your products or services. These transactions happen naturally as a result of operating your business day-to-day.
  • Investing Flow: As the name implies, investing flow covers business investments. When you buy an item, like a commercial property or equipment, that will be used repeatedly to increase your business’s efficiency or profitability, that transaction falls in the investing flow category.
  • Financing Flow: If you take out a business loan or pay dividends to shareholders, these activities fall into the financing flow category. This segment covers any transactions around dividends, debt, and equity.

How do I talk to customers about how I want to get paid?

Handling money-related conversations with customers can be tricky (not to mention awkward). But you deserve to get paid when you deliver a service or product. To ensure you get what you’re owed, follow these steps:

  1. Be upfront

Being straightforward with your clients is often the best approach. Communicate details about the payment contract, including:

  • Payment amounts
  • Due dates
  • How payments should be made
  • Who payments should be made payable to
  • Where payments should be sent
  1. Talk about your billing process.

Be clear about how and when clients can expect to receive invoices—this prepares them for what’s to come and is another way to delve into other payment-related topics.

You can easily send and track invoices like a pro using invoicing software like Wave.

How do I follow up on outstanding invoices without upsetting a customer?

For many small business owners, dealing with outstanding invoices is a reality. No matter how organized you are, you may have a few clients who need to pay on time (or at all). When that happens, here are a few things you can do to connect with your clients without ruffling any feathers:

Automate the process

The best way to handle invoices and payments is by automating the process.

Invoicing software makes it simple to customize invoices, send billing and invoice reminders, and receive instant updates for your invoicing and payment data. Automating these tasks removes them from your to-do list and can help you get paid faster.

Get on the phone.

If you still have an unresponsive client after a month, it’s time to pick up the phone.

First things first: Make sure they received your invoice. There’s always a possibility they were busy, and their email changed, or, if you’re dealing with a larger company, your email could have been sent to the wrong person or department. There’s also the possibility that they saw it and pretended they didn’t.

Once they’ve seen your invoice, you can discuss its past-due status.

Everything you need to know about cash outflow

There are many ways cash can leave your business. Here are a few best practices to help you better manage that money:

Managing payroll

Of all the payments you’ll make as a small business owner, one of the most important will be to the people who help keep your doors open every day—your employees. Manage your payroll well, keep employees happy, and avoid trouble with the law by following these tips:

  • Please write down your payroll dates: It’s easiest to make payments when you know when payroll is due. If you know this, then all you have to do is make sure you have enough cash on hand as the date approaches.
  • Pay electronically and keep immaculate records: Automating payroll can be a timesaver. Just be sure to classify each employee correctly (as a W-2 or 1099 worker) so their paychecks reflect the right deductions and taxes. Payroll software can help you run payroll for contractors and W-2 employees quickly and accurately. They also keep pay records for each employee, which comes in handy during tax season and for other purposes as they arise.

Paying contractors

In the UK, you typically won’t withhold federal or state income tax from your contractors’ pay—they’ll be responsible for paying for those on their own.

If you’re processing payroll through a system like Wave, you can easily distinguish contractors from W-2 employees, so the correct withholdings apply to each employee. Wave also tracks all your payments to have a readily accessible list of all payroll amounts and dates when and if you need it. And with the self-service features of Payroll by Wave, employees can access any pay stubs they need anytime.

Paying bills

For bills, know who you owe, how much, and when they’re due. Keep a summary of these basics readily available and review them regularly.

The timing of this review depends on the nature of your business and whether or not you’re having cash flow issues. Plan and compare your expenses to your estimated revenue. 

Once you understand how to manage the money moving out of your business, you’ll have a firm cash positioning and can maximize how you use your cash flow statement.

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