11 – Understanding Cashflow
In this very useful lesson you will learn to calculate how long it will take to break even, but it does not accurately reflect how payment and billing cycles work. You don’t pay pennies for flour each time to make fried chicken; you pay hundreds of dollars every few months to get bulk supplies.
If you earn a paycheck and pay bills, the basic concept should be familiar. Bills have to be paid by a certain day. Meanwhile, you receive paychecks on other set days. The trick is to make sure you have enough money in your bank account to pay a bill. Sometimes waiting until a bill is almost overdue is necessary to ensure you have the money to pay for it.
For a business, the “paycheck” occurs through sales and the “bills” are the cost of running the business. Unlike paychecks, income from sales is often unpredictable. When payment delays occur, you still need the money in hand to cover your expenses. The amount of cash you need to keep on hand is your working capital and the movement of cash in and out of your business is known cash flow.
ASK YOURSELF
- When will I actually get paid?
- When will I have to pay my expenses?
- Will I have enough cash on hand? If not, how can I change my processes to make it work?
- How much do I need to keep in reserves?
| TIP: Delays in payments are common if you sell to other businesses and invoice them for payment at a later date. To minimize the impact on your business, look for ways to invoice quickly and pay your bills more slowly. Also, limiting inventory to what you actually need may prevent cash from being tied up in excess supplies. |
Monitoring your cash flow and making plans to cover the gaps can be the difference between staying afloat and going out of business. Tracking your sales and expenses month to month can also expose patterns to help make more accurate sales projections. Luckily, you don’t have to do the math by hand. Many great resources exist to help small business owners.
Complete the assignment before moving on.