A small business owner should not overlook the importance of acquiring new customers, earning a profit, and exceeding their sales goals or quotas. Cash flow is another vital aspect of a business’s success, but, unfortunately, some business owners don’t understand its importance.
Monitoring and managing a company’s cash flow is necessary to keep daily operations running smoothly, making it even more relevant than earning a profit. So why is cash flow essential to a small business? Consider the brief guide below to learn more about the concept and its benefits to small Canadian businesses.
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Understanding the Importance of Cash Flow
Cash flow is a bookkeeping term describing the money going in and out of a business. It is not the same as profits and sales, though many people equate the two concepts. A business owner may have cash inflows and outflows from sales and expenditures, respectively. However, cash flow is often more complex than that.
To understand how much money a company generates and how much it spends through cash flow, a business owner should consider how cash inflow is vital to its success. It involves everything that generates money for a business, including:
- Loan receipts
- Payments and sales
- Savings interests
- External financing
Keeping track of a business’s sources of cash will reveal how much is available to pay for essential expenses like rent, workers, and group insurance for employees. The greater cash flow the business has, the more seamlessly it will operate and the more opportunities it will have for expansion and investments to grow the company.
Cash Flow Statements
Many small businesses use a cash flow statement to monitor their finances. A financial document with a detailed analysis of a business’s cash flow during a specific period, the cash flow statement explains where the company spent or received cash under three major cash flow categories:
- Operating Cash Flow: This section discusses the net cash the business generates during typical daily operations. Positive operating cash flow is essential for establishing and maintaining business growth.
- Investing Cash Flow: Investing cash flow is how much net cash a company makes from investment-related actions, like purchasing physical assets or investing in securities.
- Financing Cash Flow: On the cash flow statement, the financing cash flow will refer to money transfers between the business and its owners, investors, and creditors. It may include equity, debt, and dividend payments.
How Small Business Cash Flow Differs From Profit
Profit and cash flow are not synonymous. A business can appear profitable and not have a positive cash flow.
Profit is how much money remains after an enterprise deducts its total costs from revenue. A company is in financial jeopardy if its operating expenses or expenditures are higher than the revenue because it functions at a loss instead of a profit.
The primary difference between profit and cash flow is that the latter is the net amount of money that transfers in and out of a business. Profit is what’s left after all payments.
Why Is Cash Flow Important to a Small Business?
Small business owners sometimes struggle to keep their enterprises afloat because they put more focus on generating sales. While that is not entirely the wrong business direction to follow, some businesses don’t receive money immediately after closing a deal.
For example, a business could sell services to a client and then invoice for payment. Receiving the complete payment could take days, weeks, or months. Even though the business made a sale, the cash inflow might not be immediate.
Without considering cash flow in its daily operations, a business could run into serious issues. While waiting for customers to complete their payments, outflow is still necessary to pay bills, employees, suppliers, and other debt.
Below are other reasons why cash flow is vital to the success of a small business.
1. Make Better Business Decisions
Having accurate cash flow statements will maintain awareness of the exact amount of money the business has at any time. There is no need to guess or assume. When it’s time to make critical or everyday financial decisions, a business owner can do so confidently with reliable financial information on which to base their decisions.
Some months may have a weaker cash flow than others. Without knowing the status of the business’s funds, spending money could cause significant issues and throw off the financial reports.
2. Know Where the Money Is Going
Another benefit of the cash flow statement is that it shows where the business’s funds go. Profit and loss statements don’t display that information. However, understanding the business’s expenditures clarifies where it is spending money, how much it is spending, and where it can cut costs.
3. Manage Short-Term Debt
Many small businesses have debts, especially during the first days of their inception. A positive cash flow will help the company stay on top of repayments, ensuring that the business has enough funds to pay suppliers, employees, and debtors. With sufficient cash flow to make on-time payments, the company will develop good, long-lasting relationships with suppliers, investors, etc.
4. Acquire Financing
Even with a positive cash flow, some situations may require a business owner to take out a line of credit for the business. Though many business owners seek financing when their enterprises experience financial difficulties, the chances of acquiring credit rise substantially when companies have a positive cash flow.
The reason for the improved chance of acceptance has to do with repayments. With good cash flow, a business owner shows potential lenders that they can meet all repayment requirements on time. They may also use the cash flow statement to negotiate lower interest rates.
5. Grow Your Business
Even if a business is currently small, it’s possible to expand into new markets to generate more significant revenue. However, business growth requires careful planning and capital. Growing the business at the wrong time or the wrong way can produce catastrophic long-term results.
Whether growing the business requires hiring more employees, upgrading technology, buying new stock, or renting an additional facility, it will need money. Unless a business owner effectively monitors and manages the cash flow, they won’t know if the business has enough funds to invest in itself.
6. Navigate Downturns
Even successful small businesses have downturns where money isn’t coming in as it should. It doesn’t matter if the slump is due to financial mismanagement or the economy. When times get tough, the business will have enough funds in the bank to maintain its operations, thanks to a history of positive cash flow and careful financial monitoring.
Read more about managing your cash flow in our Bookkeeping for Small Business article.
Improving Small Business Cash Flow With Group Enroll
Now that you have a comprehensive answer to the question, “Why is cash flow important to a small business?” you can take your modest company to new heights by ensuring that your hardworking employees have the group benefits they need to be healthy, productive, and happy with Group Enroll.
Group Enroll is an insurance broker. At Group Enroll, we help businesses across Canada find the best solutions to grow their enterprises, including group insurance coverage. We help people compare and pick the group insurance product that suits their needs, such as:
- Extended Health Care
- Group Dental Insurance
- Group Disability Insurance
- Group Life Insurance
- Group Retirement Savings Plan
- Health Care Spending Account (HCSA)
We partner with some of the nation’s leading insurance providers and will gladly help you secure affordable insurance products. Our address is 10 Great Gulf Drive, Unit 5, Vaughan, ON, L4K 5W1, but you can contact us at [email protected] or fill out our online quote form today.