Is your business profitable? Are expenses from different product lines lower or higher than the revenue generated by that product? Are profits growing or declining?
For a small business owner, it’s important to think over these type of questions if you want a clear idea of where your business is going.
Many new businesses and startups are more focused on cash flow than on sales, often not knowing the difference or effects of each.
If you offer products or services on credit, then it is possible your cash flow is positive in a particular period as customers make payments for past sales. The high cash flow might cause you to think that your business is booming and you might ignore current sales levels and future cash needs. If sales are declining, or not increasing in line with expenses, it will negatively impact the business in the long run.
Many businesses run out of money for this very reason. Inexperienced businesses often get caught up in the now and forget about the future. The owners are excited about high positive cash flows in the current term while ignoring sales (I.e. promotional activities). So, while expenses accrue regularly, sales might fall due to the business owner failing to conduct adequate advertising . This causes future cash flows to be insufficient to cover future business needs, causing the business to become insolvent.
Insolvency means the business is unable to fulfill obligations as they become due.
So what is cash flow? Cash flow is money coming into or out of the business. While there are different types of cash flows, the most important is operating cash flow (cash flow generated from normal business operations).
While revenue is income from products and services sold. Because revenue is recorded at the time of sale whether cash payment was received or not, a business may be profitable (revenues higher than expenses) but still not have the necessary cash to fulfill obligations. (This is why it’s important to study the Statement of Cash Flows along with the Income Statement.)
Written by Kokab Rahman.
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