When it comes to operating an SME, it’s important to remember that there is a difference between profits made by the company and cash. In no SME, are the profits used to buy anything the company needs, or to pay employees. Profits are used for the expansion of the company, reduction of debt and to pay bills; however, salaries and other expenses must always be paid with cash. If a business manages to not run out of said cash, the business can operate and sustain itself indefinitely. If a business runs out of cash, it could only stay open for a few weeks or months, regardless of how profitable they are. Having a strong cash flow means that SMEs can keep their doors open, and invest in newer and better products, which ultimately ensures success.
What is cash flow?
Cash flow refers to the difference in the amount of cash available at the beginning of a period (“opening balance”), and the amount available at the end of that period (“closing balance”).
When talking about cash flow, there are two different types of cash flows:
- Cash inflows:
This is the income of cash into the business from the sale of goods and services.
- Cash outflows:
Payments made with regards to the needs of the business, e.g. raw materials, transport, labour and electricity. These are necessities in the business which cannot be left unpaid.
Healthy cash flow is the driving power behind successful SMEs:
It’s very important to remember, if your expenses exceed the amount of cash you have available in your business, you have a cash flow problem. This is applicable to all SMEs, big or small and in any industry. Many SMEs have hit the bump of properly managing and sustaining their cash flow, which causes many problems for the business itself, and in the worst-case scenario, causes the business to close its doors indefinitely.
When the business is not bringing in enough cash to cover all the expenses, it is referred to as negative cash flow, and this means that the business is bringing in less cash than its spending. This causes a big problem for SMEs when it comes to paying immediate bills, as they do not have the cash at hand to do so. This leads to SMEs having to borrow money in order to pay these bills. However, many financial institutions (e.g. banks) often don’t loan money to businesses who have failed to keep their businesses afloat in terms of cash flow. Cash shortages and limited borrowing options are two of the main reasons that SMEs are closing their doors, and rarely remain open after four years in business.
It should come as no surprise that positive cash flow is the life force of SMEs. Positive cash flow is critical to sustaining and growing a business. Additionally, it also puts the business in a much better position when it comes to negotiating more appealing financing terms with lenders and bigger discounts with suppliers.
This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice. Errors and omissions excepted (E&OE)