The Difference Between Cash Flow Problems and Cash Management Issues
Cash flow problems arise because of cash management issues.
Most businesses have a method of transaction management (ie bookkeeping via Quickbooks, Xero or a simple spreadsheet), but many don’t have a method of cash management.
A method to manage cash is needed (along with transaction management) to ensure that a business is financially healthy, and good cash management will prevent cash flow issues.
Many businesses say they have cash flow problems when in fact it is that they are lacking a cash management system.
Excellent cash management would ensure that cash flows are sufficient and in the right timing to fund and sustain a business.
A staggering 80% of companies fail because of their inability to manage cash flow properly (ie not having a cash management strategy or system).
Even at a business’s infancy, managing cash should be one of the top priorities. It sets up a good foundation for growth and sustainability.
Cash Flow Problems
The cash flow statement comprehensively reports and records all the inflows and outflows, including operational expenses, debt repayments, investment activities, and revenue.
Thus, a deep understanding of a business’s cash flow cycle is a must for effective cash management. It is the starting point to better cash management, and it is also the end goal for doing such.
A business owner’s goal should be to improve cash flow through intelligent cash management.
One of the most common cash flow problems is not having enough balance between the inflow and the outflow of cash at any given time.
If a company’s money is less than how much is required to pay off debts and operational costs, for instance, it would have no choice but to borrow money. In worst-case scenarios, startups that otherwise have high market position have no choice but to declare bankruptcy just because cash flow problems cripple them.
Ironically, companies poised for growth are those that fall into this trap. These companies have to hire new talent, increase inventory, and invest in new machinery or tools. Without considering cash flow, they would get to a point where instead of making a profit, they would have to first pay for all the additional costs incurred. It can be a vicious debt cycle, one that you wouldn’t want your business to be in.
The starting point for better cash flow is first to ensure that your finances are correctly recorded and reported, and secondly to plan your cash flow. With reliable and accurate bookkeeping and accounting, you can analyse cash management decisions moving forward.
You can only really asses if you have real cash flow issues, once you have your cash mangement sorted out.
If you still have cashflow issues, then here are cash flow strategies that you can use.
Cash Management Issues
Big corporations have chief financial officers, and they are the ones responsible for ensuring that cash flow is adequately managed. They devise strategies and make sound decisions based on factors such as economic climate, internal timelines such as payment deadlines and market activity, and the company’s current assets and liabilities.
However, for a small business with more straightforward cash flow, it should be more than enough that the owner is well aware of how cash moves in and out of the company.
Understand how and when the cash moves is the starting point to managing cash. But a cash management system is ultimately needed at any size so that you can manage cash effectively and efficiently.
In our opinion the best cash management system is Profit First. This is a book written by Mike Michalowicz and you can download the PDF here.
The Profit First Approach
While traditional accounting’s formula is:
Sales – Expenses = Profit
The Profit First formula reverses this by taking out the profit first, and then whatever is left should be allocated for expenses.
Sales - Profit = Expenses
While technically speaking, the numbers should be the same; it makes a whole of difference in the way a small business would approach cash management.
The main principle is turning accounting upside down so that you earn profit no matter what, and then work your way around whatever amount is left for expenses.
This is a transformative approach, as it forces you to be more innovative, more mindful of how you handle your business’s day-to-day operations in the most cost-efficient way.
Simple as it may seem, the Profit First method of accounting has a knock-on effect on the overall cash management strategies a company has in place.
With such a straightforward and optimistic treatment of profit, it warrants a mindset that furthers a business forward instead of stagnating in a pool of debt and poor cash flow.