As an e-commerce business owner, you might find yourself constantly worrying about bringing in profit and neglecting the importance of cash flow in the process. Think of it this way - even if you may have sold most of your goods and raked in a huge profit, that amount of money will not be beneficial to your business unless it is on hand. In other words, cash flow is important to ensure the smooth day-to-day operation of your business.
At this point, if you need to turn to accounting experts for your e-commerce business, we’re here to help. Otherwise, read on to find out how increasing cash flow is a smart financial move for any business.
Difference Between Profit and Cash Flow
Cash flow and profitability are not the same.
Cash flow describes the net amount of cash and other equivalents being transmitted into and out of a company. Profit is the financial benefit achieved by a business when the revenue generated by the company’s activities surpass the costs, expenses and taxes associated with sustaining the activities.
A business could be profitable and yet unable to pay the bills. In a similar vein, even if a business meets all its financial obligations, it does not mean that it is making a profit.
Timing is everything when it comes to cash flow. Your business might be making money over a month or year, but you may find yourself struggling with cash flow on a specific day or week.
Elizabeth’s online apparel business makes an average of HKD $1,000 in profits per month. However, this amount is only credited to her business bank account at the end of the month. Since her bills are due at the beginning of the month, she has problems with paying her bills and finds herself having a cash flow problem. In this situation, she would have to review her processes, eliminate excess expenses and gradually improve her cash flow.
While profit is undoubtedly crucial to any business, the pulse on your business’s financial health ultimately depends on your cash flow. If your company is not profitable on paper, it is an indication that the company is not in good shape and you would have to increase your sales or decrease your expenditure to keep things running. On the contrary, even if your company is profitable, this does not mean that your business can operate on autopilot. You will still have to keep an eye on your cash flow so you can continue moving in the right direction.
How To Calculate Your Operating Cash Flow Ratio
The operating cash flow ratio, also known as a liquidity ratio, is an indicator of whether the cash generated from a company's operating activities can repay its current liabilities.
To work out this number, simply follow this formula:
Operating cash flow = Cash flow from operations/ current liabilities
Cash flow from operations: this number can typically be found on your company’s statement of cash flows. Otherwise, use the following formulation to calculate your cash flow from operations:
Cash flow from operations = non-cash expenses + net income + changes in working capital
Current liabilities: this refers to the obligations that are due within a year, including accounts payable, short-term debt and accrued liabilities.
Helpful Cash Flow Management Tips To Grow Your Business
Managing cash flow may sound like an intimidating process, but this is a necessary practice to allow you to better understand your company's cash flow and set priorities for spending.
Here are three simple tips that can help you practise effective cash flow management:
Maintain your books properly
Maintaining your books properly means recording your transactions, keeping track of payments and invoices and understanding where your money is. When done correctly, it becomes effortless to trace back later to sort out the profits and losses you require for tax or auditing purposes.
If you are overwhelmed, consider outsourcing your bookkeeping, so you’ll always have an expert to manage your cash flow and point out any financial shortcomings you should address. Our team at Osome can help you sort out your books in minutes and reconcile them every 24 hours so you don’t have to waste precious time retracing old invoices.
Monitor cash flow
Cash flow management involves close monitoring of cash flow, so you can keep an eye on the amount of money you have spent, how much you have on hand, and how much you will soon have after receiving the money owed to you. Develop a daily cash report to understand how much money your business can spend, without needing to delve deeper into credit or debit every week. Furthermore, this report can provide you with crucial information on profit, loss and expansion possibility.
Pay attention to your current financial situation and look out for patterns, including how long your clients take to make bill payments. If there are any problems, you need to be able to identify the causes early to effectively act on them.
Forecast the following month’s cash flow
A good cash flow forecast allows you to prepare for periods when cash might run low. It is always important to make plans ahead so you can work out contingency plans for your company to sustain during times of negative cash flow.
As with every business, every week has its challenges with varying demands. While there is no guaranteed method of forecasting the exact cash flow you require for the following week, it would be helpful to do up an estimate of the expenses you would require. As a gauge, run through a typical week in your business and use that to plan and practise better budgeting for the upcoming week. In this way, you can always predict the amount you will have in your bank at the end of the month, regardless of your business’s profitability.
Benefits of Maintaining Healthy Cash Flow
The importance of healthy cash flow can never be undermined. In a nutshell, maintaining positive cash flow preserves liquidity in your company and helps contribute to growing your business.
Practising cash flow management allows you to witness these benefits:
Meet and pay obligations on time
With healthy cash flow, your business can make timely repayment of obligations. In the long run, this will help to strengthen the business relationship with your suppliers and other third parties you deal with. Should unfortunate circumstances involving cash flow problems arise in the future, your working partners may be empathic and extend credit terms. Additionally, if you need financing, your timely repayments will reflect well on you and aids in your credit rating.
Alleviate the pressure of unexpected expenses
Unforeseen circumstances including financial crises, pandemics and natural disasters can put your business under tremendous pressure, but having healthy cash flow can help to alleviate the unnecessary stress.
With adequate cash flow, you can have peace of mind knowing that your business’s daily operations can run smoothly and you can meet your financial obligations. This allows you to concentrate your time on expanding and building a successful business.
Grow the business
If you are looking to expand your business, good cash flow management can mitigate your dependence on external resources. In the situation where you require a bank loan, you would also be in a stronger financial position to discuss repayment terms and interest rates.
Get Your Paperwork in Order and Stay on Top of Your Finances
Long story short, the amount of cash flowing through your business is crucial for its success.
Starting out might not be an easy process, but we’re always here to help. We collect data daily from the different online platforms you’re selling on and convert it into your accounting books. By the way, we also assist when you need a hand with company secretarial tasks in Hong Kong. Talk to us to learn more.