Cash flow is crucial to the livelihood of every small business. Learn how to create a cash flow management strategy for your business.
Cash flow is often referred to as the lifeblood of a business, and with good reason. Without consistent cash flow, many business owners struggle to make payroll, pay vendors and suppliers, and keep their doors open. In fact, one study found that 82 percent of business failures are caused by poor cash flow management.
One common, and often very dangerous misconception is that profit and cash flow are the same. It’s important to understand the distinction between the two, as profitability alone isn’t enough to ensure the success of your small business.
Profit vs. Cash Flow
Simply put, cash flow refers to the money coming in and out of your business. While profit and cash flow go hand-in-hand, being profitable and being cash flow positive are two very different things.
In order for your business to be profitable, your net income must be greater than your expenses for a given period of time, whereas being cash flow positive means you have enough liquid capital to cover your daily business expenses.
As a small business owner, the amount of cash you have on hand at any given time can determine your ability to maintain standard business operations. In fact, it’s entirely possible for a business to be profitable on paper while also being cash flow negative.
For example, let’s say your company sold $10,000 in widgets during the month of May, resulting in a net profit of $6,000. If several of those customers fail to pay those invoices in a timely manner, your business could become cash flow negative, despite being profitable on paper. Ultimately, this could impact your ability to cover essential expenses, putting your business at risk.
Needless to say, cash flow management is essential to the success of your small business. The challenge for most small businesses is that cash flow continually fluctuates as money comes in and bills come due. This makes it incredibly important to have a solid cash flow management strategy in place.
Cash Flow Management For Small Businesses
The benefits of cash flow management extend far beyond simply knowing when debts are due and when your next influx of cash is expected. Having a solid cash flow management strategy in place can also enable you to:
- Identify opportune times for you to reinvest in your business or make major purchases without risking your ability to cover expenses.
- Demonstrate to banks or other parties that your business is a good candidate for financing.
- Make your business more attractive to potential buyers.
Creating cash flow projections
When it comes to creating a cash flow management strategy for your small business, cash flow projections are often a good place to start. Cash flow projections are estimations based on a number of factors, including customer payment history, future expenses and obligations, and vendor practices. Your cash flow projection should include the amount of cash you have on hand and the amount you expect to receive, less any fees, invoices, or taxes you’re expected to pay.
If you’re not using bookkeeping software, the SBA suggests using a spreadsheet to keep track of all instances in which money is entering or leaving your business.
Understanding your cash flow schedule
The next step is to review your payment dates and determine the best time of the month to pay your debts or collect on receivables. For instance, you might make sure that any client invoices are set to be paid two weeks before your credit card payment is due. Careful scheduling can be crucial to your ability to build and maintain a positive cash flow. By mapping out your month, you’ll know when to tighten your belt and when you can afford to relax.
Getting Cash Flow Under Control
Customer credit policy, invoicing, and collections are all key components of successful cash flow management. In order to more effectively manage your business’ cash flow, you’ll want to consider the following questions:
- How much risk can you take in regard to low cash reserves?
- How much time do you give customers to pay?
- Who is responsible for making sure customers pay on time?
- What happens if your biggest client pays late or not at all? Who steps in?
The following steps can help you resolve these questions and get your cash flow under better control.
Establish or review your accounts receivable policy
Having a clear customer credit policy is key to improving cash flow management. If you find that collecting payments is a problem, consider offering a penalty for late payments, or put a reward system in place to incentivize early payments. If you haven’t done so already, consider charging cancellation or hold fees on orders or services if payment isn’t rendered in a timely manner.
Automate your invoicing process
If invoicing is a hefty undertaking, consider investing in software that allows you to automate your invoices. By automating invoices, you can improve your overall recordkeeping, as well as improve financial accuracy and efficiency. Likewise, consider allowing electronic payments. Not only can this speed up the time between invoicing and payment, but may also help reduce the risk of payment fraud.
Do your due diligence before extending credit
Late payments can have a significant impact on your ability to stay cash flow positive. Even a minor payment delay can create an unexpected cash shortage. When beginning a relationship with a new client, do your due diligence. To help you assess risk and assign appropriate limits, consult industry credit groups and ask for financial statements and credit references from the new client.
Keep an eye out for red flags
If a customer or client has historically paid on time, a few late payments can be easy to overlook. While it’s important to maintain a positive relationship with your customers, it’s also crucial that you protect your business.
Make sure you have a collections policy in place and that you stick to it. Stay persistent and unapologetic in your follow-up. You may need to involve your legal team and extend a payment plan. To further protect yourself, consider collecting a down payment or instituting a late payment fee.
By being upfront about your policies, making smart credit decisions, implementing swift and consistent follow-up and considering technology options to facilitate deposits, you can dramatically improve your receivables process.
Finally, when creating a cash flow management strategy, be sure to explore the tools offered by your financial institution. Some banks offer treasury management tools designed to help improve cash flow, streamline payables, manage liquidity and mitigate unnecessary risk exposure.
For more cash flow management tools and resources for small businesses, explore our cash management solutions.
