Cash flow refers to the inflow and outflow of cash, which is needed for a business to run effectively. For any business, managing cash flow is extremely important. While sales, production, and other areas are important for a business, financial management is crucial. Managing finances, especially cash flow plays a very important role in ensuring the successful day-to-day operations of a business.
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Effective management of cash flow helps ensure the inflow of cash is more than outflow, allowing the business to have sufficient cash for its effective operations.
Cash flow management mistakes to avoid
While managing your finances, there are some common small business cash flow issues you commit. These mistakes can severely affect the smooth operations of a business. Many entrepreneurs who are technical persons tend to commit these mistakes. The impact of these mistakes can affect the finances of a business. This is why it is important to know more about such common mistakes.
Here are five common cash flow management mistakes that entrepreneurs and managers need to avoid.
1. Not monitoring cash flow regularly
A good entrepreneur should not leave the finances entirely to a finance manager or CFO but needs to keep an eye on what is happening. Monitoring cash flow is something entrepreneurs need to do. The first thing a good entrepreneur needs to do is to keep an eye on all the inflows of cash and the outflows. It is also required to break down incomes and expenses. Identifying recurring payments is important as they have an impact on cash flow.
Determining both income and expenses is important for better cash flow management. While determining expenses, it is important to look at those expenses that have a long-term impact. While it is easier to work out expenses, it is not so easy to determine incomes. Estimating possible customers and the sales from each of them can help. Making a cash flow plan with all this is helpful. Once this is done, regular monitoring using software or even a simple spreadsheet can be helpful.
2. Not being proactive about collections
Invoices only give an estimate of the cash that would come in. This cash needs to be collected. This is where many businesses tend to falter. They tend to be passive in following up with clients for payments. This is a big mistake that can severely affect cash flow. Many clients juggle with their payments and prioritize payments to those vendors who follow up for the payment actively. If you are not proactive, then your client may not prioritize your payment, causing delayed payments.
Delayed payments affect cash inflow. This can have a serious impact on cash flow management. As a result, you may end with a shortage of funds for crucial activities like production and expansion. If this continues, it can even lead to a cash crunch. You need to be more proactive in ensuring you get payments on time. Considering charging penalties for late payment to prevent delays in payment.
3. Confusing profit and revenue
Revenue is the money you are getting for the products you sell and the business you run. Revenue does not equal profit. Unfortunately, this is a mistake many businesspeople make. They focus so much on profit that they do not track cash flow. This can be a very big mistake. It could lead to a cash crunch where you fail to pay vendors on time and even end up not having money to pay salaries. Profit is the result of accounting, while revenue is the actual earnings.
Some businessmen make a related mistake. They may see a lot of cash coming in as revenue and assume they are profitable. They may miss out on the cash outflows. At the end of the day, they find out that their outflow and their inflow are the same. Worse still, they may end up with more outflow than inflow. As a result, they can end up with no profit. This is why it is important to be able to distinguish between revenue and profit.
4. Not paying attention to inventory
Inventory is a very important part of a business. It needs to be monitored regularly as it plays an important part in the finances of a business. It is very important to have optimal levels of inventory. Too much inventory leads to wastage. As an entrepreneur, you will be sitting on excess inventory, which may not move in the market. This is improper cash management.
To less inventory is also a problem as you may not be able to fulfill customer orders, which can affect your business. This is the reason entrepreneurs need to pay attention to inventory for effective cash flow management. Better inventory management can help ensure you have the right inventory levels. You need to focus on inventory turnover, which is the extent of the inflow and outflow of inventory. This will help improve cash flow.
5. Not having a cash reserve
Cash flow management is not about just managing the inflow and outflow of cash. You need to have a contingency in place. A cash reserve is an emergency fund that you need to maintain to deal with contingencies. A sudden emergency can affect your business leading to your cash flow is affected. This is where a cash reserve will be helpful.
The cash reserve will help you handle an exigency well. Ideally, your cash reserve must be equal to two months of the expenses you need to operate your business. This ensures that even if you have two terrible months of cash inflow, you can still run the operations. Failure to have this reserve can seriously disrupt your business operations. Build your cash reserve today so you are prepared to handle any situation.
Avoid these mistakes for effective management
As an entrepreneur, it is important that you are aware of these common mistakes and how to avoid them. This information can help you manage your cash flow in a more effective way. It can help you save money and manage cash flow better. It also saves time that you may need to spend fixing these costly mistakes.