Knowing when your money comes in and when you pay invoices gives you a perspective on your financial situation a budget, profit-and-loss statement, general ledger or balance sheet can’t. Even if your business is profitable, poor cash flow management can lead to costly or embarrassing situations you might have easily avoided. That's why it's beneficial to do a cash flow analysis.
Knowing when your customers’ payments will arrive and when your bills are due lets you see if you will have enough cash on hand to pay your bills. If you book a $20,000 sale that costs you $10,000 to fulfill, that sale might hurt you if you must pay your suppliers and employees that $10,000 within 30 days but your customer doesn’t have to pay the $20,000 bill for 60 days. A cash flow analysis allows you to maintain adequate cash reserves to cover situations such as these.
If you use credit to pay your bills, a cash flow analysis helps you prepare to keep enough credit availability or arrange for a loan in plenty of time. In addition to estimating cash flow based on expected expenses and income, build in a cushion for cost overruns and late payments or bad debt. Mismanaging your credit not only leads to an inability to pay your bills, but it can also result in declined charges, interest penalties, fees and damage to your credit report and score.
Knowing your cash flow situation will help you make adjustments to keep your business operating. For example, if you are paying down debt each month, a cash flow analysis might alert you to the fact that you need to save that cash to build your reserves one quarter. You might be able to reduce your spending in a specific area during a period of slow receivables. In some instances, you can defer your salary, paying yourself what you didn’t take when your revenues are better. You might ask customers to pay earlier or work with your creditors to delay payments to help you through a short-term cash crunch.
If you have plenty of profits on paper, that won’t help you keep your staff working or suppliers sending materials if you can’t pay them on time. When you can’t make payroll, put down deposits or order supplies and materials, you can lose your ability to make your product or provide your service. Even a temporary loss of production can put a significant dent in your profits and throw your budget out of whack. In addition, an inability to fill orders starts rumors spreading about your company and might cause your customers to find a new supplier.