Virtual CFO | Understanding Cash Flow
One of the problems that business owners often run into is that they have poor understanding of why they are making money in their business, but they are running out of cash says it virtual CFO. In order to help business owners become more financially aware their business, helping them understand business financing can go a long way to businesses succeed in business. Since 50% of all businesses are out of business within five years, 29% of those failed businesses say that running out of cash was the reason their business failed. Financial literacy will go a long way to helping business owners succeed.
By understanding the answer to several questions, business owners can start to understand how cash flow and profit works in their business in order to pay the things you need to pay for such as loan repayments, shareholder loans payroll and bills. One of the first questions that business owners should understand about business finances is revenue added to the income statement at the time of invoice or at the date of payment? Virtual CFO explains that it appears on the income statement as soon as it is invoiced, but just because it is on the income statement doesnít mean the business gets paid for it. Business owners need to understand that items will show up on the income statement much sooner than money will be in their bank.
When a business owner uses cash to buy assets, is there profit and loss statement affected? Business owner purchases assets as virtual CF the money comes out of their bank account right away, showing business owner that they have decreased cash, but those assets donít show up on the companyís profit and loss statement in the same way. Business owners need to be aware that even though theyíll have less money in the bank, assets purchased in the business show up on the profit loss statement in different ways.
The third question that business owners should understand when it comes to business finances as virtual CF is how do shareholder loans affect cash flow? One thing that business owners should understand is that the dividends will never show up on income statements. The owner has to take money out of the business, so the business must profit at least as much as the owner takes out. By always looking at profit and loss statements, business owners can be assured of never taking more money than they profit out of business.
The last question is why should profits be at least as high as loan payments and shareholder draws? This question is very similar to the last question says virtual CFO because shareholder draws and loan payments do not show up on profit and loss statements. Whatever a business needs to take out of the business in order to pay loans, capital leases, shareholder payments, the business owner needs to understand that it will not show up on the profit and loss statement, but they must have the money in the bank. The business needs to make at least the same amount of money that a business owner will be take out for loans, leases and shareholders payments, or else the business will run into a cash flow problem.
50% of all businesses are out of business within five years and 29% of those businesses say that they ran out of cash says virtual CFO. By helping business owners understand business finances, they can make better financial decisions in their business that can help them not only avoid running out of cash, but help them succeed in business. As Warren Buffett said, accounting is the language of the business. Business owners who can increase their chances of succeeding by learning the language of business.
By answering some commonly misunderstood questions that businesses have been business, entrepreneurs can be better equipped to on their business and avoid the common Biffle of running out of money. The first question is how can a sudden increase in revenue place strain on cash flow? Virtual CFO says that this is a problem that continues many business owners because they believe that since there revenue suddenly increases, the just have more money. But the reason why this is the case is because as the revenue goes up, the expenses also goes up. The reason why this puts a strain on the business is because the expenses in the business go up immediately and the business does not get paid for the bills they send out until later – usually by a month. Business owners need to be prepared for when their business suddenly sees an influx of business and they get busy, that they need to be prepared for pay increase bills sooner.
The second misconception with business finances is business owners donít understand what happens to their cash balance when they pay off payables and credit cards. Virtual CF says that most business owners will pay bills as soon as their money is collected. So it looks as though they have no money in the bank. Since those bills hit the income statement much earlier by weeks or a month, it they appear to business owners that they have no money for a reason. When business owners are prepared for that lag when invoices are received and then when they pay off those invoices they can understand that even though it shows as having no money in the bank when they should have money, what the reason is.
The third thing that business owners can understand when they are learning business finances, is does the principal portion of loan repayments show up on the income statement? Virtual CFO says this is one of the most common misconceptions that business owners have because no principal of the loan does not show up on an income statement only the interest shows up. Business owners need to be aware that only the interest shows, so if the business owner is paying a loan, they need to have profited at least the principal amount in their business in order to pay that. They donít keep that in mind, they may not understand why they donít have money in the bank, or wonder where the money in the bank went.