These days, your money has to work for you. Tracking cash flow is important but getting the most out of the cash that comes in requires shrewd decisions about how to invest it. It's not always easy to determine which area to put it into for the best overall result to your finances.
Let the cash sit in your account
Not the most effective use of cash. Returns are usually low so any cash that does need to be put aside for specific projects such as future expansion should be moved to a higher yielding investment. When determining where to invest this cash, first determine how much risk you are willing to accept, and secondly, how easily the investment can be converted back into cash should a more opportune way of spending it come up.
Invest for the future
Regularly moving a percentage of your deposits into a retirement fund will prevent the money from dribbling away into other uses and provide you with a more secure future.
Spend cash on expenses
Retaining the necessary cash reserves for day-to-day operations and emergencies is necessary but the way in which it is done can make your cash flow situation and your life easier. Make provision for taxes by regular contributions to an estimated tax account. Transfer a percentage of funds from your main account into a payroll account to ensure the funds are there to pay employees and to facilitate record keeping. Keep cash available for the longest time by holding off paying bills to near their due date unless there is a worthwhile discount for paying earlier.
This is a wise choice since it promotes business growth. In reality two factors influence the choice. First, there may be a number of assets that could be purchased and you need to estimate which will provide the best return on the investment; secondly, the return from purchasing the asset must be better than that available from any other form of investment. Your accountant can show you how to use a financial tool called net present value (NPV) analysis to compare the expected investment and return on different projects to see which one offers the best profitability. You may find that your best investment is, in fact, the stock market or a money market fund.
Pay off debt
In general, since interest rates run higher than almost all after-tax return rates on investments, it is a better decision for a business to pay down debt whenever possible to avoid the difficulties that come with servicing it. There is no investment risk involved and paying your debt usually doesn't involve any additional fees. When paying existing debt it is better to pay a revolving line of credit rather than an installment debt. This retains your borrowing potential when the need for additional debt occurs.
Return the cash to shareholders
While it is tempting for the entrepreneur to take the money as salary or a bonus, or return it to other shareholders, often the more prudent choice is to reinvest the funds to help propel business growth. Returning cash to shareholders is a last option when there are no good assets to purchase, debt and expenses are at reasonable levels, and there are no high yielding investment opportunities available.
Cash management is essentially about putting every dollar that comes in to working in the most productive way it can for you. Inefficient cash management practices can lead to a build-up of non-productive cash or its disbursement in sub-optimal ways. Selecting the most efficient way of using cash involves an awareness of what is available along with the opportunity costs and trade-offs associated with spending it on one thing rather than another.