Cash flow is the blood flowing through the veins of your business. In simple terms, it measures cash coming in versus cash flowing out at a particular moment. Though it is straightforward, it is not necessarily easy. Even a highly profitable enterprise on paper can get into trouble if it can't manage its cash flow properly.
Why Cash Flow Matters
Your business needs cash to function on a day-to-day basis. You may have to pay for stock and services or have staff that needs wages. Rent and services need paying, insurance, and possible government fees, and taxes must be paid on time to the IRS.
All businesses have ebbs and flows. There will be periods of high income and other times in the cycle where income is weaker. Therefore, a business must be able to maintain a positive cash flow. If you cannot do this, your business will likely be in danger of failing.
What Does Cash Flow Positive Mean?
Simply put, its more “cash in” than “cash out” of your business. Any business wants to make a profit. That is, you want your income to exceed your expenses. The problem is even if your future income makes you profitable, you can still stress your cash flow over a short period of time.
For example, let's say a business has $50,000 of cash on hand in a particular month. During that month, it has $100,000 of expenses and makes $150,000 in income. It looks like you've made $50,000 in profit for the month. Job done, right? Let's finish for the day and head down to the pub for a drink and a celebration.
Not so fast. What if your client takes 30 or 60 days to pay your invoice? Suddenly, you may be in a spot where your cash flow is negative and you’re going to have trouble meeting your obligations for the month.
To be cash flow positive, you have to understand how money moves in and out of your business and be able to allow for any upcoming and unforeseen expenses, like a customer’s slow payments.
What Causes Cash Flow Problems?
Cash flow issues can result from basic problems such as not having enough customers or clients, not charging enough for your services or letting expenses get out of control.
However, problems can appear in other areas. Clients may be late payers or not pay at all; you may be hit with an unexpected tax bill or face an increase to the minimum wage or insurance premiums, and rents can rise.
Tips for Managing Cash Flow
The good news in all this is that you can take steps to improve your cash flow.
1-Create and track cashflow projections
Scrambling for cash to stay afloat can become soul-destroying very quickly. To avoid being caught in this spot, keeping accurate accounts is essential to understanding your business's financial position at any point in time. You can use previous income and cash flow statements to predict likely results for the next three to six months.
This information can help you spot any potential shortfalls and give you time to prepare for them.
Check out our YouTube video detailing the steps of creating cashflow projections.
2- Establish A Relationship With Lenders
The worst time to get someone interested in lending you cash or investing in your business is when you are having cash flow problems. The chances of anyone being interested in lending to a company in dire straits are low. It is much easier to build a connection based on a future line of credit before you need it. Bankers will look to secure a loan against assets such as:
Accounts receivable (unpaid customer invoices): Usually, this will be a revolving line of credit, based upon a percentage of total accounts receivable. Normally these are due within a 60-90 day period and are one of the most common forms of business financing.
Inventory: Inventory is popular with lenders as it can be sold and turned into cash. Bankers will prefer finished over raw stock as they can sell it without the need for any further investment.
Equipment: While technically not a short-term loan, you can use equipment to secure fixed-term finance when a cash injection is needed in an emergency. The more specialized the equipment is, the harder it is to borrow against.
A newly established company or a business with poor credit may also be able to sell some of their accounts receivable if they can't get a line of credit. A third party purchases the accounts after negotiating a price and then collects the funds owed.
3- Get Invoices Paid Quickly
As a business owner, you want the gap between providing your goods or services and having your invoice paid to be as small as possible.
Collect Payment upfront
Depending on the type of industry you are in, you may be able to collect fees for services before they are provided. For instance, if you run a childcare center, you can run weekly tuition payments with a parent’s preauthorized ACH agreement.
Send Online Invoices
Offering online invoices is one of the best ways to have customers pay invoices in a timely manner. Using accounting software that would allow you to email an invoice to your client and them have the ability to pay it online will drastically cut your accounts receivable.
It is best to issue an invoice at the same time you provide your service or product. Make sure the invoice makes it clear that payment is due on the day the invoice is issued. Don't offer payment at the end of the month or after 30 days. As the saying goes, if you give someone an inch, they will take a mile. Also, the invoice should clearly state that you will charge interest if payment takes longer than 30 days. Finally, you must stay on top of your accounts receivable and establish a process for chasing late or delinquent payers. Some steps the process could include are:
Send a letter asking for payment 10 days after the invoice is issued.
After 20 days, send a more aggressive letter demanding payment.
If an account is 30 days overdue, combine a phone call with a third letter.
It is essential to contact possible delinquent payers early and offer various options for payment, whether it be paying by credit card or payment plan if they have difficulties. You should develop a policy for dealing with late payers and stick to the procedure.
4- Work With your Vendors
Just like you want payment from your customers, your vendors want payment from you. Delaying payment as long as possible under the terms of your agreement will give you a chance to plan your expenses. On the other hand, early payment can have a nasty effect on your cash flow.
It is vital that your business maintains a good credit rating. You also don't want to harm a relationship with a critical vendor and should pay as promised. If you find yourself in trouble and have to delay a payment, contact the vendor immediately and explain your situation. You should also have a plan for paying the vendor and finalizing your debt.
5- Maximize Income and Minimize Expenses
There are a variety of methods of getting more cash flowing through your doors. A 50% security deposit upfront will mean you're not as exposed to significant liability for expensive orders. If you work with extended contracts, set up a payment schedule with cash coming in at regular intervals. If you provide a regular service, setting up a subscription where payments are made in advance could be the way to go.
Minimizing Expenses
The best way to remove stress on your cash flow is to remove the need to spend cash. Or at the very least reduce the cash outflow. There are some very effective methods for doing this.
Trim the Fat – Non-essential expenses, does not grow revenue
Repair capital equipment instead of replacing it. A regular maintenance program could end up saving you considerable amounts in the long run.
Buy used equipment. Used equipment in good condition is usually just as good as new machinery, but you can obtain it for a fraction of the cost.
Delay product upgrades. Put off upgrading products for as long as possible while your current systems can still do the job.
Barter for products and services. A vendor who is also a customer may be interested in a trade. You can both make payment with an exchange of finished goods. The beauty of this is that although your goods will be valued at retail price for the purpose of payment, they will only cost you the wholesale price to provide them. You will effectively gain a discount on your expenses.
Key Takeaways
Having a cash reserve built up is essential for a business owner to get a good night's sleep. Cash is the lifeblood of trade, and if you run out, you won't be able to operate. By smoothing expenses, preparing in advance to reduce surprises, and maximizing income, you should be able to gather enough cash reserves to cover your costs. WATS CPA can help with cash flow tips for your small business.