According to the Economic Times, 90% of small businesses fail, and this often happens due to poor cash flow. Not to be confused with profits, cash flow refers to the cash you have on hand and the way it flows in and out of your business. To be successful, you have to manage your cash flow effectively, and to do that, you need to understand cash flow, profit, and burn rate.
What Is Profit?
Profit is simply your revenue minus your expenses. In other words, it’s the money you bring in minus the money you spend. When you use accounting software such as QuickBooks, you can easily generate a profit-and-loss report or an income statement that shows you these numbers. But there are more details needed that directly affect your cash flow.
For one, debt payments for loans and equipment don’t show up on these statements. In addition, the tax you owe is generally not included in profit-and-loss reports either, and if you use accrual-based accounting, this report often includes income you haven’t actually received yet. With accrual-based accounting, you count revenue as soon as you agree to a deal. For instance, if a client signs a contract, you count the revenue at that point. You don’t wait until the cash exchanges hands.
What Is Cash Flow?
Cash flow looks at all the above elements and considers the timing. A very simple cash flow chart includes the money going in and out of the business every day and the amount left over. The amount left over is your cash flow. To stay on top of your business finances, you need to make sure you have enough cash on hand to cover payroll, utilities, and any other bills.
To emphasize the importance of tracking cash flow, imagine that a business makes a deal to create 1,000 widgets for a client. The contract is worth ₹20,000, but the company doesn’t get paid until the widgets are complete. To make the widgets, the company needs to spend approximately ₹8,000 on supplies, payroll, and other expenses. On paper, the company has ₹12,000 in profits. But it has no cash.
Without cash, the company can’t buy the supplies or pay the costs to make the widgets, and as a result, it risks going under. Now, if the company had created cash flow projections, it would have realized the upcoming cash flow issues. And it could have made other arrangements such as requiring the client to pay half the cost upfront or taking out a short-term loan.
What Is Runaway?
Many businesses don’t deal in large contracts like the example above. Instead, they make lots of little sales, which can sometimes be hard to predict. In both cases, you may want to track your runaway. Your runaway is your cash balance divided by your burn rate. Your burn rate refers to how quickly you spend money.
To calculate runaway, you simply add up your expenses for a month. Then, you divide that into the cash you have on hand. Let’s say you have ₹1 lakh and you spend ₹50,000 per month. When you divide your savings (₹100,000) by your monthly expenses (₹50,000), the result is 2. You have two months worth of money. Even if you don’t make a sale during this time, your business will still have enough cash to survive. But if you don’t start bringing in money by the end of the two months, you won’t be able to cover your bills.
Profits are great, and arguably, they’re the reason you’re in business. But to keep the doors open and the lights on, you need cash. To ensure you have it, you need accounting software that helps you track the numbers and predict what’s going to happen next. QuickBooks can help by creating cash flow statements, forecasts, and projections.