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Why It is Critical That Entrepreneurs Understand Cash Flow

American consumers generally understand the cash flow principle. Money comes in with the weekly paycheck. It flows out as bills are paid. Simple enough, right? For the entrepreneur though, cash flow takes on a whole new meaning in a business setting. It is critical that entrepreneurs understand all the nuances of cash flow before launching a new enterprise.

We have all heard stories suggesting that the majority of small businesses fail within the first year. It is not true. No one quite knows where that mistaken statistic came from, but the U.S. Chamber of Commerce sets the record straight:

  • 80% of small businesses survive the first year
  • 70% survived the second year
  • 50% are still in business after five years.

That being said, the reasons small businesses fail within the first two years are numerous and varied. But the number one reason is lack of cash flow management skills. This lack of skill is a direct result of a lack of knowledge.

It is Not So Simple in Business

A 2019 U.S. Bank survey among small business owners revealed that 82% of all business failures are the result of cash flow problems. That makes cash flow management the number one problem. A close second is starting a new business venture with too little money. Approximately 79% of all failed businesses start out in this position.

The point of all of this is to say that cash flow management is not so simple in business. At home, you are able to count on a fairly steady income. You know what you are going to get paid each week; you know what your monthly bills are. Managing cash flow isn’t that difficult unless you have trouble controlling your spending habits.

In business, there are never any guarantees. Revenues often vary from one month to the next. So do expenses. Then there is the added challenge that comes with customers not paying their bills on time.

Invoices Are a Valuable Tool

Effective cash flow management in a business setting requires a thorough understanding of how money flows in and out of the business. But understanding alone will not do the trick. Business owners need tools to help them manage cash effectively. Business invoices are one such tool.

As you know, factoring invoices is one of the easiest and most effective ways to manage short-term cash flow needs. Invoices are sold to a factoring company in exchange for immediate cash. The factoring company charges a fee for its services. It can be a flat fee or a percentage of the invoices in question.

What makes invoice factoring so useful? A couple of things. First and foremost, invoice factoring is not the same thing as a bank loan. It doesn’t come with prohibitive interest rates and a long repayment term.

Second, factoring invoices is a way to raise cash on-demand. A small business owner whose cash flow remains steady can go on as normal. But when a dry spell hits, they can turn some of their invoices into cash to keep things running.

Education Is the Key

So many businesses failing due to a lack of cash flow knowledge and management skills should suggest the obvious: business owners need to be educated. Indeed, education is the key to making sure a business maintains enough cash on hand to cover daily operating expenses.

Cash flow management is critical in the business environment because revenue streams vary. When a business owner has a good handle on cash flow, things tend to work out well. Otherwise, the business owner could be in for a bumpy ride.