Why is Cash Flow Important?

You’ve heard it all: cash flow is king, cash flow is the lifeblood of your business, cash flow is mission-critical. Yes, cash flow is all those things, but do you know why or how? Let’s take a step back because a basic understanding of cash flow and how it can make or break your business may just be your saving grace.

The truth is that if you can understand and master cash flow management, you’ll dramatically increase your business’s chance of survival. Poor cash flow management is the second biggest cause of startup failure, so if you can overcome this bad boy, you’ll have one less obstacle in your way.

What is cash flow?

First, let’s start with the basics. What is cash flow? Cash flow measures the movement of money in and out of your business during a specific window of time. Positive cash flow means you have more money coming into the business than going out. Negative cash flow (as you could guess) means you have more money leaving the business than coming in. 

Why is cash flow important?

Here are three reasons cash flow is critical to your business. 

1. Make your payments on time.

Unfortunately, the time for you to pay the bills and the time for your clients to pay you doesn’t always line up. By tracking your cash flow, you can make sure you have money (or will have money) on hand to pay what you owe. By making timely payments, you’ll improve your credit score and conjointly your position to score top-notch financing in the future. 

2. Afford what your business needs (when it needs it).

By maintaining positive cash flow, you’ll also have capital on hand to provide whatever your business needs. Whether you need to fix a damaged vehicle, patch a hole in your restaurant’s roof, or hire extra help for the busy weekend, you’ll have the capital you need when you need it.

3. Grow your business.

Owning a business isn’t all about putting out fires and getting by—it’s about building, thriving, and expanding. Positive cash flow management will help you set aside capital to invest in your business’s future. 

By staying on top of your cash flow, you’ll know if you can afford a commercial mortgage to expand to a second location. Or you’ll know if you can hire additional employees to support the business’s demands. These choices won’t be guesswork—they’ll be calculated decisions. 

Cash flow vs. profit.

While they are both important metrics, cash flow and profit have some key differences.

• Cash flow is the tangible amount of money going in and out of your business every day. If more is coming in than going out, you have positive cash flow. If it’s the opposite, you have negative cash flow.
• Profit is the difference between expenses and revenue in a time period. If you made more than you spent, the remainder is called profit. If you spent more, you’re not profitable.

Cash flow vs. revenue.

Cash flow and revenue are not the same things. Revenue measures how much money your business is making, while cash flow measures both how much you’re making and how much you’re spending. Cash flow also takes into account the liquidity of your cash. Let’s explain this with an example.

Kyle is an employee at the local grocery store, and today is payday. Kyle has worked hard all month, and he’s delighted to receive a hefty $250 check at the end of a long shift. Ecstatic, Kyle decides it’s time to treat yo’ self and makes a detour to GameStop on the way home. Money’s been short recently, but he’s excited to be able to afford some entertainment for himself finally.

He makes his way to the back of the store and picks out a few new games he’s had his eye on, the price totaling $150. No problem, right? His $250 check should have no problem covering this expense. Well, not quite.

See, it’s the end of the day, and the bank has already closed, so Kyle will have to wait until tomorrow to cash the check. Technically, he doesn’t have cash in his wallet right now, so he can’t spend it. This scenario shows a cash flow issue—Kyle’s made revenue, but he doesn’t have cash yet. No games for Kyle. Poor Kyle. 

This example illustrates a similar problem that kills so many small businesses. Revenue does not equal cash on hand.

The real king is you.

In all reality, cash flow isn’t king—you are. By taking the reins of your cash flow, you can steer your business in the right direction. Don’t let negative cash flow become a problem that strikes your business at random. Track the ins and outs of your money, plan ahead, and let cash flow make your business—not break it.

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