It’s a common lament among small-business owners and entrepreneurs: “If I’m making so much money, why am I always broke?”
The problem often boils down to the difference between net income and cash flow.
Net income is the bottom line, or the profit or loss that is recorded on your income statement after accounting for all business costs and expenses.
Cash flow is money that has been collected and is available for you to use.
The income statement is updated whenever you make a sale or complete a job.
However, you may not see payment for these activities for 30, 60 or even 90 days. Even though you have generated revenue, it is not yet available as cash for you to spend.
A drastic imbalance between net income and cash flow can lead to a situation where you are generating healthy profits from your business activities, but you don’t have enough cash to cover expenses such as overhead, labor and materials.
The money has been earned and recorded, but it hasn’t been collected and thus is not available to support your operations.
There are a number of ways that cash can get trapped on the balance sheet.
The two most common are for customers to delay payment on receivables and for inventory levels to get out of hand. Here are some ways you can avoid falling victim to your sales success by running out of cash:
- Monitor cash flow regularly. Get into the habit of staying on top of the amount of money you have available at all times.
- If your cash flow level falls below a certain threshold, or if you see an adverse trend developing, look into financing options before things reach a crisis point.
- Use payment policies that enhance cash flow services. Ask customers to make deposits on their orders. Offer discounts to those who pay up front, or use a tiered payment schedule that encourages early payment or pre-payment for goods.
- Take advantage of your creditors’ payment terms so that you retain use of your cash for as long as possible.
- Ask suppliers for flexible payment terms as these can be more beneficial to cash flow than discounts or low prices.
- Avoid keeping excess inventory on hand. Use a just-in-time inventory management system, buying what you need only when you need it.
- Issue invoices promptly and follow up on payments that are past due.
There are many examples of good, solid companies that failed because they could not generate enough cash.
Cash flow is a better metric of a company’s financial health than net income.
Indeed, operating cash flow is the lifeblood of a company and the most important barometer that lenders and investors use to measure a firm’s financial health.
Your cash flow statement provides immediate insight into your financial position at any point in time and reflects your ability to remain solvent in the near term.