Cash flow management: Planning for a safe and steady course

Proper attention to the flow of cash in business will reduce the chance of crashing on the rocky shoals of financial embarrassment.

In any business, cash flow planning is a method of ensuring cash needs do not exceed cash resources. Cash flow is not about profitability. Although profits do provide a source of cash, using cash flow as a budget tool takes into account the scheduled and the unscheduled demands for cash with equal streams of cash inflows. In short, proper checkbook management is the purpose of understanding and utilizing a cash flow statement.

New businesses should have sources and uses of funds statement that details where the funds are coming from. Some examples are owner investment, loans, and grants. The uses will include; purchasing of fixed assets, raw or beginning inventory, recruitment and training of staff, and enough cash to carry the business until cash is received from customers. Working capital will roughly be three months of the projected sales. In addition, a reserve should still be maintained.

Sales projections should be based on the capacity of the production and marketing strategies. From purchasing raw inventory to converting it into a finished product requires the addition of labor expenses. Unless sales are pre-paid, the company needs to take into account the time between the credit sales until payment is received. This will add time to the cash to cash cycle. The time lag directly influences the amount of working capital needed to begin the business.

Fixed expense cash outflows items like rent, maintenance, insurance, legal fees and utilities will need to be paid from reserves even if no sales are experienced. One exception to the fixed cost of operations that does not enter into the cash flow statement is depreciation, as it is not “paid”, but it does influence overall profitability.

Some difficulties in managing cash flow may be incurred. Oddly enough, growing too fast can be just as dangerous as not making the sales target. Ramping up too quickly will put great demands on the need for more inventory and labor along with increases in accounts receivable and perhaps the need for more production capacity. Planning is the key.

Every business needs to make something, market it and then management it. Cash flow management, while a quiet part of the production, provides a vital linkage between the cost of production and the collection of invoices of sales.

Michigan State University Extension educators working with the MSU Product Center counsel aspiring and current business owners on good management practices, like cash flow projections. 

 

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