Just like you, your business needs periodic health checkups to ensure all systems are a-go. Accurately measuring cash flows is an essential element in figuring out exactly how your business is performing. Maintaining vigilant cash account analysis can help you better navigate the market and make decisions regarding when and how to take your business to the next level.
Basic Accounting: The Cash and Accrual Methods
There are two methods of accounting that are most commonly used for determining profit and loss; accrual and cash. Accrual accounting is best used for forecasting and potential profitability measurement, not account health. The results of the accrual accounting method can give a false readout when measuring your business’s cash flow. This is due to the fact that this method only shows potential earnings as opposed to actual cash on hand. Measuring business performance using the cash method can provide you with the most accurate results for your actual cash flow since it does not take into account funds that have not yet been collected from customers for services or products rendered.
Operational Cash Flow
One of the most popular ways to accurately measure cash flow is through core business operations. If your bread and butter business stems from providing a specific service, such as tax preparation or IT, than your core cash flow measurement should rely on cash in and cash out as it relates to your essential service. An example of how business operations cash flow works can be broken down into two elements and how they relate to one another; namely, accounts payable and accounts receivable.
If your company uses a certain product to create your merchandise, you may stockpile the product so it is on hand to meet customer demand for your particular merchandise. This means you will pay ahead for product you do not yet need. In business operations this can occur often, and paying for the stockpiled product may cause your balance sheet to be in the negative for a certain time. Once orders are placed for your merchandise, and the product stockpile is used, your merchandise markup will then show your cash profit.
Analyzing Your Earnings Statements
Once the business/customer transaction is complete, you can evaluate your earnings statement. This report will show the products as an expense and the merchandise sales as profit. Subtracting the two will provide you with your total cash profit from the sale of your merchandise.
Deducting Your Expenses
Your business expenses are your overhead, or what you need to continue doing business at your current rate. For example, these can include rent, telecom costs, employee expenses, and vehicle costs. These must be deducted from your profit to provide you with an accurate depiction of where your cash flow is after you receive it. When your business cash flow seems slim, this is the first place you should look when determining where the bulk of your profits are going.
Making Adjustments According to Your Cash Flow
This business health check up should be preformed quarterly to provide you with an accurate view of your accounts payable and receivable. By performing these measurements consistently you will gain insight on seasonal dips or rises in profit, how to budget your expenses better, get a handle on bad customer debts, and which products and services are making you the most cash.
Once you determine your business operations cash flow, you can then take into account cash additions from investments and free cash. But as a rule of thumb, when determining business health, business operations cash flow should be the core measurement; only add the icing only after you have determined the bulk of your flow comes from your actual earned profits.
Following these tips will ultimately help you to accurately measure your business cash flows.
Image via Quin Dombrowski