Financial Management: 2 Key Elements of Business Cash Flow
Business cash flow has two important characteristics: Time and risk. Read on to learn more about the importance of risk premium and the time value of your money in financial management.
What is financial management?
As a business owner, you have to make critical decisions every day to meet your short-term and long-term financial goals. In order to do that you need to organize your finances by doing the following:
Bookkeeping process is a vital aspect of the business accounting. By keeping tabs of sales, payments, receipts, and purchases and other transactions, you will know how much money is coming in and going out. In short, it is the best way to record your business cash flow. It will also help you know whom your organization is working with. If something goes wrong with your credit or cash transactions, you can easily verify it from the books and make the necessary correction through your bookkeeper and accountant.
Making an estimate of the future financial performance of your business is one of the most important steps in growing your business. Problems may come up as you do business every day, but the process of making strategic financial projection helps you understand the real status of your business. It helps you evaluate and re-evaluate the strengths and weaknesses of your company, and your standing against your competitors.
- Financial statements
The financial statements of any business include a statement of your financial position, such as your assets and liabilities, a statement of your income and expenses, and a statement of your equity or retained earnings. Lastly, it includes your business cash flow statement or the report of your cash flow activities such as operations, investments and financing.
Every entrepreneur wants to obtain the right amount of money to start his or her business or grow an existing one. Those who cannot qualify for traditional financing, opt for alternative financing options.
Time Value of Money Explained
It is better to receive money now than later. This principle is rooted in the concept of interest which comes in two forms-simple and compound.
Simple interest is the interest that you have to pay on the principal. For example, you borrowed $100 with a simple interest of 5%. For the first year, you are going to pay $5 in interest. If you haven’t paid it for 5 years, then you will have to pay $25 in interest ($5 x 5 years). In the same way, if you invested $100 and it grows at 5% each year, over five years, your investment will become $25 more.
Now, let’s take a look at compound interest. If you are going to invest money, receiving compound interest is a good thing. But, it’s definitely a bad thing for your business, if you have to pay compound interest.
With compound interest, your interest will be calculated not only on the beginning interest, but on all interests accumulated until you pay off the loan.
For instance, if you invested $100 at 5% compound interest, the first year interest would be $5. On the second year, the interest would be calculated on the beginning amount which is $100 + $5 or $105. So, the interest would be $5.25. If this will continue in 5 years, your $100 principal will grow by $27.63 more or an end value of $127.63.
Now, imagine if the compound interest will apply to your loan-your interest will be more dramatic than a simple interest, and it is not something that every entrepreneur looks forward to.
The risk value of money is due to two major risks that every business faces: the internal and external risks.
How do you compute the risk value of money? Estimate the quantity by multiplying the probability that the negative event will happen, by its likely impact using the money terms.
For example, you can invest $2000 and gain $0, or invest $4000 with $0 returns, depending on the impact of a negative event.
Every day you are facing the possibility of suffering from business losses. You may also get inadequate profits. It is because the preferences of the consumers change from time to time. Competitors can also formulate powerful strategies to snatch your existing customers in a snap and the economic impact of government policies and current events can make or break your business.
So, how do you protect your finances from the risk elements while doing business?
A sound financial management plan serves as a buffer to business risks like low profits, losses and events that could break your business apart. If you have a good budget based on your current business cash flow, sufficient emergency fund, savings account and insurance policies that cover potential losses in production, equipment breakdown, market price fluctuations, you can quickly recover from them.
But, if you have limited financial resources, it is important to look for a financing company that can provide you with emergency funds to finance your business. It can be in the form of business loan, short-term loans or any type of loan that could cover your needs.
Learn more about securing your business cash flow by contacting us.