How to Manage Cash Flow for Small Businesses Explained

Introduction

One of the major duties of a small business owner is in managing cash flow. A company might have a high level of sales, gain new customers, and be profitable on the books, but not be profitable in terms of paying bills or suppliers, paying wages or salaries, or paying rent. This discrepancy occurs because profit doesn’t equal cash. While the revenue is increasing, unanticipated expenses, unpaid bills and seasonal variations can be a severe financial strain.

Growing consistently known as the primary cause for small businesses to fail is cash flow difficulties. Many business owners are so preoccupied with making more sales, which they don’t worry about when money is coming in or going out. This can lead them to find out about shortfalls in their finances at the last minute, and may only be able to afford high-interest loans or emergency money.

Industry research shows that the number one reason why SMBs fail is due to cash flow issues. Fortunately, these issues can be avoided without having to know much about accounting or financial modeling. Simple systems, sustaining good habits and affordable technology can make significant contributions to improving the financial health of small business owners.

This article discusses seven successful cash flow systems that will help your small business make accurate cash flow predictions, receive payments sooner, deal with slow seasons and make smart use of your profits all year long.

Why Cash Flow is more important than Profit?

A lot of business owners, mistakenly think a successful business will have healthy finances. Profit is an accounting term and cash flow is the actual receipt and payment of cash. For instance, the company can send out an invoice that could be worth thousands of dollars and not receive the money until March or April. In the meantime, the operations costs keep going up. Employees, supplies, software, taxes and rent are due and must be paid whether or not customers pay their bills.

When cash flow is poor, it can have an impact on all facets of the business. Owners can defer their supplier payments, cut down on marketing, delay equipment additions, or over-depend on credit facilities. These decisions over time can restrict growth opportunities and cause financial stress.

Flexibility comes from having good cash flow management. Having consistent cash reserves gives businesses more negotiating power with suppliers, the opportunity to capitalize on growth potential, the ability to invest in tech, and the confidence to handle economic uncertainty. The aim is not only to get through the lean months of the year but to be able to function consistently throughout the year with adequate liquidity.

1. Create a Basic Cash Flow Projection (13 Weeks)

One of the best instruments to enhance financial visibility is a 13-week cash flow forecast. A rolling 13-week forecast works on a more short-term basis as compared to the Annual budgets which may change very quickly.

It’s simple to do. Make a spreadsheet, with seven total columns for the next 13 weeks. Document any anticipated cash receipts, such as customer sales, recurring cash receipts, loans received, and other income. Then, record all anticipated outflows (e.g., payroll, taxes, supplier invoices, subscriptions, rent, utilities and loan repayments).

New observations made at the end of each week, and the forecast to be extended one week further at that time. This rolling approach enables a potential shortage to be identified in advance of an emergency.

No, the idea isn’t to get it right the first time. Even an 80 percent accurate estimate gives more information to help make decisions than no estimate at all. As time passes, patterns can be identified, helping business owners to predict slower times, work out payment plans, and make adjustments on time.

Checking the forecast once a week, every Monday, develops a money consciousness. Business owners will be able to make well-informed decisions, rather than just after the issues arise, due to the fact that they will have insight into future cash needs.

2. Accelerate Accounts Receivable Collection

One of the primary reasons for cash flow delays is late payments for small business. Many companies spend a lot of time creating invoices and probably not a lot of time making sure that they’re paid quickly. There are ways to improve accounts receivable processes that can help to maximize the amount of cash available without increasing sales volume. Send invoices ASAP after products or services have been delivered. Sometimes the invoices are not generated on time and this directly results in the delay of payment.

Confusion is lessened and quicker action taken by providing clear payment information. All Invoices must contain due dates, accepted payment methods, late payment policies and contact details for customer queries about the invoice.

Reminders that are automatic work best. Setting reminders prior to, on, and after the due date eliminates the need for untimely follow up activities. There are a number of accounting platforms these days that have built-in accounts receivable automation features that ease this procedure.

Track important metrics like the average collection period (ACP) and overdue invoice percentages. An enterprise can track these measures on a regular basis and pay forward customer payment issues before they get out of hand.

3. Strategically Optimize Payment Terms

Payment terms can have a major impact on the cash flow of businesses that are not always recognized. Net-30 terms can be effective for big business, but can cause undue stress for smaller businesses. Assess your existing payment system to see if it meets your cash requirements if in your business, think about cutting payment terms down to 15 days or even 7 days for bigger projects and ask for a partial payment.

Milestone billing can be very beneficial to service-based companies. Payment should occur at pre-determined phases on a project rather than when the project is finished. This not only reduces risk and increases liquidity during the engagement but also provides an overall improvement of the deal. Meanwhile, try to discuss deferred payments with suppliers if possible. The longer suppliers can take to pay in and the sooner customers pay out, the better the cash conversion cycle will be.

Communication of changes in payment terms should be done clearly and professionally. Most customers know how vital cash flow is and will adjust accordingly if they have a well-defined set of expectations at the beginning.

Here’s a list of examples of Healthier Payment Structures.

50% up front and 50% on completion.
While the standard terms are net-30, the above option is the net-15.
Instead of one-off charges, monthly retainers for services.
Milestone-based invoicing
Subscription payment models

4. Provide incentives for early payment.

When well thought out, small discounts can yield large cash flow gains. Incentivizing early payment will accelerate the process of collecting payments for customers, and ease the management of collecting unpaid invoices. An example of this is a 10% discount for paying within 10 days. This will lower the revenue per transaction but the increased cash on hand will more than make up for it.

Speeds up collection, lowers borrowing requirements, and increases forecasting accuracy as well as shortening accounts receivable administration days. Access to cash can make a significant difference for businesses that are facing tight margins or seasonal variations.

But care needs to be taken with early payment discounts. Before starting any incentive program, work out the monetary impact. If your company has lots of cash on hand, you won’t require discounts and if your company is short on cash regularly then you can find it really useful. State these incentives clearly on the invoice and talk with them onboarding discussions. If it is easy to see why your customers are going to adopt the benefits, then they will be more receptive to it.

5. Cash Flow Dips

There are predictable ebbs and flows of most small businesses throughout the year. For businesses in retail, the holiday season may be a critical time for generating sales, while for service businesses, it may be a crucial time for absorbing the slowdowns of the holiday season or an economic slowdown.

The best way to deal with seasonality is to get ready, not react. Look at historic sales data and determine trends. Knowing when revenues are likely to be higher or lower enables business owners to make decisions months ahead of time.

In more robust months instead of putting more money into discretionary spending, build cash reserves. A percentage of revenue is set aside for an operation buffer in times of lower revenue. Having multiple income sources can also help lessen seasonal demand dependency. Think about offering additional services, subscription fees, maintenance agreements or electronic products to create a stream of sales.

Managing inventory, staffing and marketing spend to fit the season helps to match the cost to the expected income. When businesses anticipate what they need to happen, they will be able to be stable without needing to make much use of external funding.

Seasonal planning questions to ask:

What are the months in the history that have the least amount of revenue?
What are the fixed costs of the business?
How much “cash on the sidelines” does a business need to see during periods of downturn?
What can you sell or rent that makes money on a regular basis?
Can there be any temporary costs savings?

6. Control Spending Through Weekly Financial Reviews

Slowly, cash flow challenges can arise from a number of little choices, not just one big deal. These hidden costs of subscriptions, wasteful software licenses, over-buying of inventory or unplanned costs can quietly deplete the cash available.

One way to establish weekly financial review process is to make it accountable and more visible. Make a special 30-minute meeting weekly to discuss the balance of your bank, outstanding bills, upcoming bills, and changes in your forecast. Prioritize cutting down on costs that are not necessary. Have an honest discussion about whether all expenses that recur are adding value to the business.

One aspect that should be taken into consideration is the management of inventory. Overstocking is a tie up of cash that could be used for other purposes. Businesses should keep an eye on inventory turnover rates and they should try not to have too much inventory. Weekly reviews also provide a chance to reflect and highlight positive trends and emerging risks. By attending to financial details consistently, you can avoid minor problems from escalating into major ones.

7. Reinvest Surpluses Gradually & Intentionally

Having positive cash flow can provide opportunity for growth, but too much growth can result in new problems. There is a tendency for businesses to go through revenue spikes and all at once invest in long-term expenses like having more employees, bigger premises or costly equipment.

A more sustainable way is to reinvestment slowly. Have a defined policy to distribute excess cash after keeping the necessary operating reserves.

For instance, a structured approach could be taken to allocate excess resources, e.g. businesses might decide to spend surplus resources in a prescribed manner:

50% of the funds to cash reserve
Focusing 20% on debt reduction
20% towards growth projects
10% to owner distribution.

This is a way to strike the right mix between growth goals and financial health.

Focus on investments that will be efficient and increase future cash flows. ROI is often gained from accounts receivable automation, inventory management software, customer relationship management and process improvements.

Don’t take drastic action when sales are up or down for one period. Reliability and flexibility are vital to sustainable growth, as is sufficient reserves.

Manage cash flow for small businesses with seven proven systems including forecasting, invoicing, seasonal planning, and expense control.

Low-Cost Tools to Make Cash Flow Easier to Manage

For small businesses, managing cash flow has never been easier with the help of technology. You can automate invoicing, monitor expenses, predict cash flow requirements and gain greater financial visibility with affordable software solutions.

A number of popular accounting and bookkeeping platforms have such features as automated invoice reminders, real-time reporting, bank reconciliation, and customizable dashboards. Payment processors offer instant payment links and various payment methods, simplifying the process for customers to make quick payments.

Spreadsheet templates are still helpful for businesses looking to low-cost solutions. An easy-to-use cash tracker 13 weeks in advance, that’s maintained continuously, can be extremely valuable with no advanced software.

The key to it is not how complex the tool is, but how consistent the use of the tool is. If there are inaccuracies in the data, or if there are only occasional reviews, even the best software will not help to improve the cash flow of any business.

Conclusion

Fundamentally, cash flow management is not a game of complicated financial theories and forecasting all the market moves. It’s about the development of dependable systems that enable visibility, promote discipline and facilitate improved decision-making.

By using a 13-week forecast, optimizing payment terms, preparing for seasonal shifts, making a review of the finances on a regular basis, and enhancing accounts receivable processes, a small business owner is able to have more control over his business.

Sometimes when you wait until cash becomes scarce there are fewer options to choose from and more financial stress. With some simple practices and affordable technology, enterprises can become more resilient, and less reliant on emergency grants.

It isn’t always the businesses that make the best money that are the most successful year-round. These are the ones who can always see the money coming in, going out and how to ensure there is plenty to take advantage of the opportunities when they present themselves.

Get more well researched information on how to manage cash flow for small businesses here.