Cash flows for a business are like three faucets pouring water into a bathtub. The trick is to keep water in the tub, or said another way, keep cash in the business. The first faucet has cash from operating activity flowing from it. These types of activities include the day-to-day transactions. When your customers pay you for your products and services, this pours cash from the first faucet into the business. The second faucet has cash from investing activities flowing from it. These types of activities include the selling of machinery and equipment. Selling investments like another company’s stock and bonds, or selling a business division. Any of these will add the amount of cash flowing from this faucet. The third, and last, faucet has cash from financing activities. These types of activities include selling your own stock. It also includes the cash you get from banks and other creditors. At times the amount of cash pouring in from one faucet can increase or decrease. It can also shut off completely. If this happens, you can increase the cash flowing from the other faucets. The goal is to keep water in the tub. Keeping a sufficient level of cash reserves is vital to staying in business. If the cash runs out, the business dries up. Enough said about the faucets. Let’s talk about the three different drains in the bottom of the tub. These drains are not your standard drains. They can get bigger or smaller. This will have an impact on how fast or slow the cash flows out of the business. The first drain is for operating activities. If your total operating cash expenses are more than the cash generated from your day-to-day activities, the cash will drain out faster than the amount of cash flowing into the business from the first faucet. If you do nothing, the cash reserves will be completely drained. The second drain is for investing activities. When you buy machinery and equipment or another company’s stocks and bonds as an investment, you will drain cash from your business. The last drain is for financing activities. This includes cash used to buy back your own stocks. It also includes payments to banks and other lenders. In a slow economy, cash flowing into the business from the operating faucet slows. A temporary solution is to increase cash flowing from the investing faucet or the financing faucet. You do this by selling under utilized assets and making loans from creditors. Be careful when you do this. As you increase the cash flowing from the financing faucet, your financing drain gets bigger (i.e. your debt payments increase). This strategy can not be sustained in the long-term; however, it does work over a short-term period. Sooner or later the cash flowing from your operating faucet needs to bring in more cash than the amount of cash flowing out of the business from the three drains. If you shrink the size of your drains, you can slow the cash flowing out. To shrink the size of the operating drain, you can decrease your operating expenses like wages, advertising, research and development, and discretionary expenses. To shrink the size of your investing drain, you can decrease or eliminate purchases in capital expenditures. Capital expenditures also called cap. ex. includes the cash spent to upgrade or acquire your physical assets like buildings, equipment, and machinery. To shrink the size of your financing drain, you can decrease loan payments by renegotiating with lenders or paying off debt and not using your lines of credit anymore. Be vigilant with your cash flows and cash reserves. Understanding how cash flows in and out of your business and knowing how to make adjustments are essential to surviving a recession.
Article Source: http://bizymoms.com/business
Joseph Phelon, MBA, CBA is a Certified and Accredited Business Appraiser with Hyde Valuations Inc. In addition to offering business appraisals and valuation services, Joseph also writes and speaks on economic and business related topics. For more information, please visit www.superiorvaluations.com