Without cash flow, no business will survive. It is often considered the lifeblood and if you run low or completely out of workable cash, it can cause serious problems. It can make it almost impossible to purchase inventory, pay the utilities, cover your lease, and even pay employees.
Unfortunately, not enough business owners are intimately familiar with their cash flow or even understand all the various components it entails.
Let’s talk about cash flow metrics.
Your cash flow is basically defined as your current assets minus your current liabilities. What are current assets? They are defined as the money you have on hand, in the bank, current Accounts Receivable, inventory, the building itself (if you happen to own it outright) and other equipment you use every day for operations.
Now, liabilities are Accounts Payable and other long-term liabilities you have on hand. This could include various business debts, including a direct business loan or line of credit.
When you divide your current assets by your current liabilities, you will be left with a ratio of assets to liabilities. This is your cash flow metric.
What should be the goal?
A healthy business should aim for at least twice as many assets as they have in liabilities. In other words, this would be a 2:1 ratio.
What about for small, relatively new businesses?
Most small, new businesses struggle to even come close to a 2:1 ratio. That’s because their liabilities often outpace assets and Accounts Receivable, at least in the beginning. However, by keeping a closer tab on these cash flow metrics, it can help a business owner or manager notice trends, whether their ratio is going up or down, or when they begin operating below 1:1 limits.
If a business is operating below 1:1, then they are operating at a loss.
Now, how can you address a cash flow problem?
The first thing to do is understand exactly where all of your expenses are. You need to be clear on where your money is spent.
Second, take a look at how other businesses are spending, especially within your industry. You may discover there are certain expenses you thought were necessary that other competitors are simply not focused on.
Third, become a micromanager, of your spending that is. The strongest and most successful leaders understand micromanaging is a poor idea, but when it comes to your spending when you want to increase cash flow, micromanaging is crucial.
The more you understand about cash flow, the more effective you can be at helping your business not just survive, but thrive.