Often when discussing their finances, small business owners regard income and cash flows as one in the same. In many cases this is true just by the nature of how they collect payment for a sale. The difference is really about timing. The important factor is that sales revenue is the actual sale or provisioning of goods and services that is recognized as the exchange happens. Cash for that revenue may or may not be exchanged at the same time the goods and services are given to your customer.
So, for instance, you made that great sale to the giant media company today for $100. Today you have sales of $100. The invoice for that sale says payable in 30 days. You will have cash flow 30 days from now for $100, today your cash flow is 0$. However, if you own a coffee shop and get cash every time you hand out a cup of coffee, your sales will equal cash inflow.
Yes, cash flow and income are different. Cash flow is the money that flows in and out of the firm. While income or profit, is what remains from sales revenue after all the firm’s expenses are subtracted.
It’s important to realize that you can show a nice net profit today, but can’t pay your employees because your cash flow is negative. Not recognizing this difference is one of the biggest mistakes a small business owner can make.
This leads us to the most important thing every business manager should understand: The Working Capital Cycle.
Cash flows in a company are best described as a cycle. Sales beget cash to pay employees and buy materials to create more products to get more sales to generate more cash. The better you are at keeping this pin wheel turning, the faster your business grows. Consequently, the faster your business expands, the more cash it will need.
The cheapest and best sources of cash exist as working capital right within your business.
Managing the amount of time between the moment when your business begins investing money in a product or service, and the moment the business receives payment for that product or service is the working capital cycle. For instance, inventory can be looked at as potential energy stored in your company. The cash used to buy or make the inventory is stored until it eventually converts into product sales.
The cycle balances two halves: cash absorbing elements such as inventory (stocks and work-in-progress) and receivables (debtors owing you money); and cash releasing elements like payables (your creditors) and financing (equity or debt). If you collect payments later, more cash is locked up in receivables, paying your suppliers later frees up cash, collecting receivables faster releases cash from the cycle.
Good cash flow comes from a short working capital cycle. For example, if you pay your contractors every 30 days but takes 60 days to collect from your customers; you have 30 days of working capital to fund. Business growth is dependent on cash, or access to cash. If a company can’t free up the cash from its working capital it will have to pursue other sources of finance, such as loans.
None of this is really ground breaking stuff, but those that can manage this cycle well, especially the early days of a business, increase their of success chances tenfold.
Bilbus is a working capital hub that enables small businesses to invoice, collect and connect with commercial lenders via a single dashboard.