Never take your eyes off of the cash flow because it’s the life blood of the business.
- Richard Branson
Staying on top of your cash flow is vital to running a small business smoothly. According to a U.S. Bank study, poor cash management is the cause of 82% of business failures. Cash flow is critical to the survival and success of your business. Without it, you cannot hire or pay employees, buy inventory, expand your operations, or secure a line of credit or financing.
Building good cash flow management habits will help your small business weather rough terrain and double-down when opportunity strikes. To help your business avoid becoming just another statistic, here are six best practices to manage your cash flow and help you grow your business at the same time.
1. Understand Your Cash Flow
One of the first things your business should do is get a 360-degree overview of its cash movements and situation. There is a common misconception that profit is the same thing as cash flow. It is not.
Simply put, your business profit equals revenue minus tax and expenses. When you invoice a customer, that counts as revenue, but you will not necessarily have cash. Your business can figure out its profit for the month and find that it has a cash flow issue. To best understand your cash situation, you will need a cash flow statement and cash flow forecast.
- A cash flow statement provides a view of your cash situation at a particular point, such as month-end. It gives you a snapshot of the cash that has flowed in and out of your business over that period.
- A cash flow forecast is a report that looks ahead to the next month, quarter, or year to predict inflows and outflows of cash based on known variables and established patterns.
2. Increase Sales, Not Expenses
Many things can put a strain on your cash flow. One of the most common is having expenses that are either out of control or simply not justified. Every business has bills to pay. But is yours efficient with its accounts payable?
If you are paying cash for equipment and inventory when there are better options, you could be straining your cash position. Take full advantage of payment terms and segment your expenses between those that are business-critical (payroll, taxes, rent) and those you have more flexibility on payment timing.
Even though it seems obvious, make customer acquisition a priority. Find ways to optimize your marketing channels so that you can acquire new business at the lowest cost. Boost your sales by up-selling and cross-selling. As long as you keep your accounts receivable under control, this combination will improve your cash flow.
3. Help Your Customers Pay You Promptly
Unpaid invoices are a significant factor in small business cash flow. One study determined that the value of small business unpaid invoices is roughly $825 billion, or about 5% of U.S. GDP. Here are some of the ways you can take control of your invoices and shorten the time between billing and payment.
- Invoice promptly — Do not put off invoicing until the end of the month or some other future date. As soon as you have delivered the product or service, send your bill immediately.
- Communicate with your clients — Many companies like to use payment apps or direct deposit for bill payment. Find out what your clients prefer and help them get set up to minimize delays or technical issues.
- Use an invoicing tool — A simple invoicing tool, like FreshBooks or QuickBooks, can help you keep track of invoices, set payment preferences and terms (per your contract), and track and issue reminders for late or missing payments.
It is almost an automatic that a small business is eager to extend credit to anyone that wants to purchase its goods and services. But, should it? Just because 30, 60, or 90-day credit is common in some industries, that does not make it a sound business decision in every case.
Whenever possible, your business should consider minimizing or eliminating the use of credit. Yes, this sounds like a radical idea, but it can dramatically improve your cash flow if you have had trouble with accounts receivables in the past. Even if you do not want to eliminate credit, it makes sense to qualify your customers before extending terms. Some of the things you can do include:
- Have them complete a detailed credit application
- Review their business credit report
- Check references
- Require a background check on larger accounts
- Research the internet (business license, social media, reviews)
- Ask for a deposit on the transaction
5. Create a Financial Cushion
One of the best ways to manage your cash flow and stay in front of problems is to maintain a financial cushion. Most financial planners recommend that small businesses have 3 to 6 months of savings in place to cover expenses.
What is reasonable for your business will depend on your industry and current situation. If you do not presently have any savings, start small and put this item in your budget and cash planning so that you can create a prudent reserve.
Another possible source of cash reserve is to have a business line of credit you can tap when you face short-term challenges. Since terms will depend on your company’s financial health, be sure to get your books in order before you apply, and only use the line of credit when necessary.
6. Plan Your Growth Strategically
Most businesses wish to expand operations and see progress in bottom-line results. But, investing in resources too soon could put a terrible strain on your cash flow. Signing a new lease, purchasing inventory or equipment, or hiring additional staff seems like growth, but you could be headed for trouble if you do not have the sales and financial cushion to support your plan.
On the flip side, getting a massive influx of sales can be a disaster if you do not have the cash on hand to support the extra labor, inventory, and overhead. In this situation, you may need to negotiate better payment terms as well as cut or delay other expenses to make ends meet as you get past this growth spurt.
For a small business, unreliable cash flow can be catastrophic. Even a short-term cash flow problem can make it tough for a company to continue operations. Outside of knowing the ebbs and flows of your business, using these best practices can help you effectively manage your cash flow and have the resources available for growth and expansion.
The team at CFO Selections can help your business with cash flow projections and management. Please contact us at your convenience for a complimentary consultation to discuss your business challenges and goals.