Current events such as the global pandemic and uncertain economy can be a few of the most significant factors for businesses to spiral down into a cash crunch or worse, bankruptcy. But when backtracked how most businesses went without adequate funds to continue their normal business operations, one huge reason is poor cash flow management.
How eCommerce businesses manage their cash flow can make or break their success. This post helps them understand this accounting aspect—from the various types of cash flow, analysis, management, to dealing with cash flow problems—and be on top of their finances.
What is Cash Flow?
Simply put, cash flow is the movement of cash in and out of business over a period of time. Take note that cash flow and profit are two different things. Cash flow is the cash or its equivalent that is generated and spent in the business, whilst profit is simply the amount that merchants get after
deducting their businesses’ operations from the total revenue.
The revenue that goes into the online business comes in different forms, such as sales, investments, licensing agreements, royalties, or accounts receivable (payments that aren’t made at the time of buying and are collected at a later date), and other cash equivalents. The money that goes out includes all business expenses, such as payroll, inventory, capital, etc.
“Cash flow is the money obtained or spent in a business.”
A healthy cash flow occurs when the online businesses’ net revenue is higher than the expenses. When the opposite happens (expenses being bigger than the net profit), it leads to a negative cash flow or cash crunch wherein businesses burn more of their inflow to pay for the expenditures. This lack of funds stops them from maintaining a normal or successful business operation.
Negative cash flow like this isn’t necessarily bad for businesses. Sometimes, it means that they are merely growing too rapidly, so they have to roll the revenue back and obtain more inventory. This would contribute to positive growth particularly when lenders or investors continue to support the business and the cash flow eventually transitions positively.
But the goal is to have a healthy cash flow consistently as much as possible, enough to give the business more room to manoeuvre and increase its valuation. This can be achieved through proper cash flow management, which begins with preparing the cash flow statement, analyzing it, and then taking further actions. The process can be made easier with the help of accountants.
Steps for Managing Cash Flows
Cash flow management is generally about tracking and analyzing the revenues that the business receives minus its expenses. The cash flow statement is closely monitored and studied to help the business obtain a positive cash flow. Here are simple steps to effectively manage their cash flows:
Improve in the aspect of bookkeeping. Businesses couldn’t smoothen their financial transactions without sorting this out. It’s a prerequisite to moving onto the next steps.
Calculate cash flow statements. This can be done quickly by the accountants or entrepreneurs themselves using eCommerce accounting software or manually through spreadsheets.
Analyze the cash flow. The very objective of this step is to evaluate the financial health of the business, particularly analyzing how the money is moving throughout.
Determining various means to maximize the cash flow. At this point, when the business shows itself to be very dependent on lines of credit to meet its needs, this means one solution—free more cash flow.
Cut spending as necessary, which is one of the ways to free more cash flow. Having analyzed the cash flow statement, businesses should be wary about which area they may be overspending on, especially the unnecessary expenses. A non-strategic schedule of payment for expenses needs to be considered as well.
Accounts receivable to be sped up. The faster they are collected, the better. Entrepreneurs have to quicken up financial transactions with their clients to obtain more cash inflow at a certain period. They can do so by setting up an efficient collection system, which includes the schedule and medium. Following up after non-payers is a must too.
Make close monitoring and analyzing a habit in the business. Done regularly, businesses are better able to deal with any problems as they arise and quickly determine every cash flow opportunity when they come. Take, for instance, clients or customers who never pay. In this case, businesses should be able to immediately recognize unprofitable relationships with clients and end their transactions as promptly as possible.
Types of Business Cash Flow
Cash flow is generally categorized into three types which are all included in the cash flow statement:
- Cash Flows from Operations (CFO) or operating cash flow.
- Cash Flows from Investing (CFI) or investment cash flow.
- Cash Flows from Financing (CFF) or financing cash flow.
The operating cash flow refers to the money that the eCommerce business generates whilst taking into account the operational expenses, which may include marketing, storage, logistics, warehouse, taxes, internet, payroll, and other daily expenditures.
CFO shows if the business is capable of paying its operating costs or if it needs external financial support for the capital. It can be calculated each day, considering both the money from sales and the cost of goods sold (COGS).
Investment cash flow, on the other hand, shows how much the eCommerce business generates from investing in any kind within a particular period. This cash flow from investing comes at a fixed amount; take, for instance, the business obtaining a new space, equipment, or other speculative assets, investing in securities, or selling their securities or assets.
Usually, a negative CFI is a result of investing a considerable amount intended for the business’s long-term health, such as research and development (R&D), which then wouldn’t fare well as anticipated.
Lastly, financing cash flow takes into account the expenses of raising the capital, such as bonds, shares, or loans. With CFF, eCommerce businesses will have to deal with banks, venture capitalists, cash injections, and more and anticipate transactions to be generally for the long haul.
Keeping track of and analyzing these types of cash flows is crucial for the business to determine its solvency and liquidity, which then leads further into the importance of cash flow management.
Why Is Cash Flow Management Important?
A well-managed cash flow provides plenty of benefits for eCommerce businesses. Sales shortfalls can be easily predicted and prevented. With a solid cash flow projection, businesses can accurately predict potential downfalls ahead of time, even up to several months, enabling them to make plans to avert the situation.
Another cause of anxiety among eCommerce merchants is whether or not they can pay their bills (to their employees or suppliers) at the set date. Having kept track of their cash flow gives them the confidence that they are well above their liabilities. They’ll know where they stand and be equipped to deal with any upcoming expenditures.
It’s also crucial for online businesses to determine when, where, and how much to spend for growth. Abrupt growth doesn’t always mean good for the business. But with a solid analysis of cash flow to base it on, entrepreneurs will know where to venture next for expansion, when they should start focusing on increasing their reach, and how much they can accurately budget toward their growth.
Ultimately, once eCommerce entrepreneurs realize they need external financing, a good cash flow system at the ready gives them an edge compared to others right at the moment of need. Whether they need more cash for capital, shortfall, etc., or ask their supplier to give them a few weeks’ breaks, banks, suppliers, or other lenders would easily consider their requests, being able to establish when and by what means they will pay and trust that they will abide by it.
How to Analyze Cash Flows
Cash flow analysis is crucial for eCommerce businesses. Aside from helping entrepreneurs determine their business’ overall financial health, it particularly projects the working capital, which is the cash amount the business has on hand to keep the operations running and get all transactions completed.
“Cash flow statements indicate businesses’ financial health.”
Generating cash flow statement is an integral part, which includes the operating, investment, and financing cash flows. However, this isn’t the only financial statement to be investigated so that entrepreneurs can accurately determine their financial capabilities.
The other two financial statements, the income statement and balance sheet, are also taken into the picture. Although cash flow puts a bridge between the two, cross-analyzing the three statements helps analysts make better recommendations to the entrepreneurs and investors to make wiser decisions.
It starts by aiming for positive cash flows wherein the operating costs should not exceed the net profit so the business can keep it up and running indefinitely. However, entrepreneurs must not start getting complacent with positive cash flow as there might be underlying business decisions that may not be sustainable in the long run.
At the same time, negative cash flows are to be closely studied too, especially since not every time this happens does it mean it’s bad for the business. It might be a temporary result of businesses investing in new products so they can generate more profit.
Pay attention to free cash flow (FCF) as well. This is the amount left after the business has paid all the operating and capital costs, which can then be used to pay for interests, down principal, or even enlarge or acquire another business.
Lastly, the margin between operating cash flow and cash inflow should be positive to ensure that the business is indeed gaining considerable net profit.
How to Deal with Different Types of Cash Flow Problems
Poor cash flow is a huge brunt to any eCommerce businesses, big or small. The goal is to free more space up for cash flow. Start with improving the inventory. A good inventory means the business is storing the right products, selling them at prices that ensure a healthy profit, liquidating excess stock, spreading out their purchases, and most importantly, boosting the value of their inventory.
It’s crucial to be ready for the worst all the time, which is what business insurance, stowed-away capital, or cash reserves ensure. Entrepreneurs need to make it a habit to review their insurance policies every six to twelve months or check whether or not their insurance policies still provide them with comprehensive coverage. Providers change their insurance each year, so entrepreneurs can always look into others to get different policies.
Payment is the lifeblood of a good cash flow. This means that on-account sales and unpaid invoices are to be taken care of immediately. Entrepreneurs have to be proactive about collecting debts, or else they’ll get their cash all tied up. Good monitoring and management of accounts receivable go a long way.
Ecommerce businesses may have to take a look at their merchant card services fees as well and make sure they don’t use tiered processing, as tiered processing payments have the tendency to overcharge their credit card processes. Entrepreneurs can opt for interchange-plus pricing and memberships for better cost transparency.
Paying for unnecessary costs or spending more on operating hours can contribute to poor cash flow. Take, for instance, hybrid stores with eCommerce and brick-and-mortar elements, hiring a support staff that would just stay at the front door and watch people come and go definitely doesn’t help. Businesses have to make sure they point out their unnecessary spending so they can manage their cash more freely.
Another way to improve the various types of cash flow in eCommerce businesses is by hiring accounting staff. They make sure that businesses get on top of their finances and even taxes. Legend Financial is here for these matters, having helped numerous businesses reach their utmost potential. Reach us today!
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