Cash flow is an important process for all businesses, so understanding how money flows through your business and what it means for the business can put you in a position to make better strategic decisions.
All businesses, large and small, depend on the cash inflows that result from sales, investments, loans, and other sources. These inflows are offset by cash outflows or disbursements to finance inventories, payroll, capital expenditures, investments, and operating expenses.
Because every business has cash inflows and outflows, it is critical that you understand the importance of cash flow. After conducting a cash flow analysis, you will see if your business generates enough cash to cover its current expenses and debts.
If your business has a positive cash flow, it means that more cash comes in than it goes out. On the contrary, negative cash flow means that your company is operating with a cash deficit.
One of the main reasons companies fail is because they lack cash reserves.
When your business operates with negative cash flow, you need to satisfy your debts and expenses through other means, such as drawing from your cash reserves. But, if your business continues to operate without bringing in more cash than it spends, it will eventually deplete all cash reserves.
On the other hand, if you have negative cash flow and have no reserves, you run the risk of defaulting on your debts and may need to obtain additional loans or raise capital by other means to avoid losing the business.
Therefore, understanding cash flow is important to a business because it reveals trends and provides information that can be used to make strategic business decisions.
Any business can be affected by unplanned expenses. For example, maybe your machinery needs to be repaired or you will take legal action against your competition for patent infringement.
Since these expenses are likely not planning, companies need to find other sources to pay for them, because if you draw this money out of the business bank account, you will not have the funds to pay your current obligations.
The consequences of poor cash management can be disastrous for businesses and their owners. A business that cannot finance current operating expenses and cannot cover payroll is effectively out of business unless immediate cash flow financing can be arranged.
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