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How Understanding Your Cash Flow Can Save Your Business

How Understanding Your Cash Flow Can Save Your Business

Let’s start by imagining your circulatory system and its major players: the heart, arteries, and veins. From your pumping heart, arteries carry oxygen-rich blood to the rest of your body and your veins carry the oxygen-depleted blood back to your heart to restart the process.

In the e-commerce world, your arteries and veins represent your cash flows, and your heart is the cash reserve. As your cash outflow, arteries represent money spent on inventory sold to customers. The veins are your cash inflow, bringing money from your sales back to your reserve.

At the literal and theoretical heart of this process is your cash reserve management, and understanding the circulatory system of cash flow will make or break your business.

Do NOT get Distracted by Profits and Losses

When it comes to your business, you want all hands on deck. You wouldn’t want to look at your business with one eye closed – which is effectively the same as only looking at your profits and losses (aka your P&L). While many people think reported profits measure the success of a business, your P&L is simply a surface level look at your business’ current financial standing. This is why in order to to deeply understand your business’ finances, you must learn and live by your Statement of Cash Flows.

While profits and losses are an important metric to track, they do not provide an accurate look at the total amounts of money moving in and out of your bank account – which is crucial to keeping a business afloat. As an e-commerce business owner, studying your Statement of Cash Flow will give you a better understanding of where you are spending your money.

Inventory and Assets vs. Flexible Cash

Take a look at the foundational formula for business accounting.

Assets = Liabilities + Sellers Equity
Assets = Liabilities + Stockholder Equity

Looking at the right side of the equation first, we have liabilities and stockholder equity. Your business’s liabilities are the costs of operations and debts owed. Stockholder equity is the combination of all company stock values, or the total number of dollars that your business would have left over if it liquidated all of its assets and paid off all of its liabilities.

Now let’s talk assets. This is where things can get tricky. Both cash and inventory are your business’s assets, but they are also inversely related: when one increases, the other will decrease (cash inflow and outflow). Managing your assets is key to maintaining and growing your business.

For example, if a business has too much inventory it’s unable to sell, the business most likely will be short on cash. This leads to bills unpaid, liquidation, or even worse – bankruptcy. On the flip side, if a business has too much cash and not enough inventory, they will be stuck in backorder limbo. This results in your potential customers going to the next seller to purchase their product. Not only are you losing money from daily operations, your competitor is taking a larger percentage of the market.

Imagine you own a toy company, and you know your slow season is the summer. During those months, if you spend less money on inventory, you can save it to invest in extra inventory during the holidays, your peak sales season. This way your business doesn’t lose cash on immovable products during the summer and will have plenty of stock during the holidays when your competitors sell out. Without an understanding of your cash flow, it’s much more difficult to forecast this kind of saving and spending.

Learn and Grow from your Mistakes

Every successful entrepreneur has failed at some point in their life, but a major deciding factor in a business’ future is how it responds to failure. A U.S. Bank study found that 82% of businesses fail due to poor cash flow management, so if you’re struggling, you’re not alone.

As an extremely useful tool to provide clarification on where your money moves to and from, a Statement of Cash Flow will help highlight the areas in which you are spending the most. Closely managing your cash flow also will help you identify mistakes early on, before they get out of control. Armed with this knowledge, you can know which areas of your business to re-evaluate to reduce cash expenditures as well as discover opportunities for increased revenue.

With the ability to sell anywhere across the world, e-commerce businesses face the potential to make more money than ever. Understanding your cash flow will help you make better decisions and identify opportunities for growth so you can flourish in a saturated market. If your business needs a more in-depth look at your Statement of Cash Flows, contact us for a free consultation!

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