The Importance of Consistent Cash Flow

by | May 11, 2022 | Accounting, Finance

Whether you run a manufacturing company or service-based business, keeping your finances in order is important. Consistent cash flow is important to ensure the business can meet its obligations and keep running smoothly. In this article, we will discuss cash flow, its importance, and a few tips for consistent cash flow.

What Is Cash Flow?

Cash flow refers to the actual cash coming in and going out of your business. Many people confuse profits with cash flow, but it is important to note the differences. Many service-based businesses perform services on credit, and accept cash at a later date. The amount owed is included in income, but is represented by an account receivable

For example, suppose your service based business provides legal services by creating contracts. The standard rate is $100 per contract, of which 20% is due upon completion and the rest within 30 days.

In the above example, only the $20 is included as a cash inflow, and the remaining $80 is classified as an account receivable. Once the $80 is collected it is counted as a cash inflow.

A similar concept applies to services or products you receive on credit. Your vendor classifies the cash you pay as a cash inflow, and the amount on credit as an account receivable.

You can see how knowing the difference between profits and cash flow is important. By keeping this difference in mind, you will have a solid grasp of how cash is coming in and going out of your business.

Why Is Consistent Cash Flow Important?

You have probably heard the phrase “cash is king.” This applies especially well if you run a service-based business. One of the most important reasons to keep consistent cash flow is the ability to meet salary obligations without delay.

Labor is the backbone of every service based business, and if your company does not have a consistent cash flow each month, your employees or contractors may feel it necessary to move to another business.

Consistent cash flow is also important when it comes to paying your suppliers and other vendors consistently and on time. Many companies do provide services on credit, but if your business is late, or does not make cash payments consistently, these companies may decide not to offer products and services on credit and instead demand 100% cash payments.

A third reason consistent cash flow is important is to outside investors or lenders. If you are looking to raise cash by offering outside investors a chance to buy part of your business, being able to show a positive consistent cash flow makes the investment much more attractive.

Similarly, banks want to see consistent and positive cash flow before making loans to manufacturers or service-based businesses.

What Are Ways to Keep Cash Flow Consistent?

One of the easiest ways to have consistent cash flow is to only accept cash payments or offer discounts for cash payments. This can be done for certain services, while others can be a combination of cash and credit, or all credit.

For example, suppose you operate a service-based business that offers cleaning services. You charge $50 for a typical house cleaning and offer a 10% discount for same day cash payments. Although this may seem like a large discount, you will save time in the future by not having to send payment reminders to customers who are past due.

Another way to achieve consistent cash flow is to use a cash collections schedule. This is a simple exercise that uses an aging accounts receivable chart to place reminder calls or send past due notices to customers.

Let’s look at a simple example chart:

30 days past due60 days past due90 days past due
Customer A$100$200$300
Customer B$400$200$50

 

In this chart above, you can send reminder emails to Customer B about their 30 days past due accounts, and collection notices to Customer A on their 90 days past due accounts.

You can make changes to suit the needs of your service based business, but the most important thing is to ensure your customers know they are past due and should make cash payments immediately.

 

We hope you have found our short article insightful and helpful. Consistent cash flow is the lifeblood of any service-based business, and ensuring your business has sufficient cash on hand is often a function of both sales and collection practices.

By utilizing the suggestions and knowledge we have discussed, you will be well on your way to achieving consistent cash flow.

For more information on the services we provide and how we can help you improve the efficiency and effectiveness of your business, check out the rest of the North Shore Accounting website!