What is the best way to manage cash flow in a small business?
For any business, regardless of its size, managing cash flow is critical to enable growth, maintain productivity and achieve long-term objectives. For smaller companies, the potential fallout from mismanaged cash flow can be disastrous. The effects can include an inability to pay suppliers, staff or other day-to-day costs or, at worst, threaten the very existence of the business itself.
There are many reasons as to why cash flow might become an issue. These can include unexpected market fluctuations, seasonal movements, new competitor offerings and, in particular, late payments from clients. Here we take a look at what cash flow is and how you can best overcome cash flow issues.
What is Cash Flow?
Essentially, cash flow means the movement of cash in and out of a business. Effective cash flow management is vital to ensure the ability to pay essential bills and grow a business. Many otherwise highly successful businesses struggle because they have failed to manage their cash flow successfully.
There are two cash flow scenarios:
- Positive Cash Flow
Positive cash flow is money coming into the business. This would generally be from sales, either through invoices settled by clients or via retail or wholesale avenues. To ensure that cash flow is positive, the funds coming into the business must exceed the funds leaving the business.
- Negative Cash Flow
If the value of funds coming into the business is less than the number of funds going out of the business, then the cash flow is negative. Particularly for small businesses, this position can cause issues is not sustainable. If a company is in a negative cash flow position, it is essential to take steps to rectify the situation quickly.
Profit is Different from Cash Flow
On paper, a business can appear profitable but still have a negative cash flow position. If sales are high, but invoices aren’t being paid in time to meet outgoing commitments, a company will be in a negative cash flow position.
Effective cash flow management is key to ensuring that a positive cash flow position is maintained, affording business stability and the opportunity to grow. Implementing efficient controls and managing expenses will allow the business to forecast potential issues and take appropriate remedial action accurately.
The business’ accountant or bookkeeper can utilise spreadsheets and accounting software to anticipate and manage cash flow effectively. Analysis of key metrics will help to differentiate between profit and cash flow and serve minimisation of negative cash flow periods.
How to Fix Cash Flow Problems
1. Utilise Technology
Accounting software will typically include options for cash flow statement generation and cash flow forecasting. These can be utilised to compare the snapshot of your current cash position with both the long and short term forecasts of your cash flow.
Incorporating client payment patterns, sales projections and other known expenditure into the estimates will enable effective planning. If potential cash flow problems are highlighted now, in the future measures can be put in place in advance to manage them. Setting up the right online business account to view company finances in real time can help with controlling and monitoring of cash flow.
2. Deposits and Partial Payments
For long-term contracts or larger orders, it might make sense to charge an initial deposit. Deposits allow the business to obtain sufficient cash upfront to meet the cost of fulfilling the order. For long-term contracts, building staged payments into the agreement ensures that the company can meet the ongoing expenses of the contract, such as materials and labour. In both cases, the business can operate in a positive cash flow position and should not need to draw upon reserves.
3. Maintain Cash Reserves
It can be tempting to invest as much as possible back into the business to drive ongoing growth. While investment in the business is essential to meet long term goals, it should be managed strategically to ensure that day-to-day operations are not put at risk. Delaying some investment in the business to maintain cash reserves can mean that the business will be able to manage periods where cash coming into the business is unreliable.
Soldo prepaid cards are an excellent solution for businesses struggling to maintain cash reserves. Prepaid business cards allow you to have complete control over employee spending limits. Soldo also provides a software system that enables business owners to get real-time visibility over company-wide spending so that you will know as soon it’s time to reduce business expenses.
4. Grow Strategically
It is tempting for any business, and particularly smaller companies, to take risks to grow. While it is essential to consider growth opportunities, it is equally important to temper these with operational considerations. Winning an important new contract can mean great profits in the long term. However, the cost of investing in employees, materials and equipment can place cash flow under considerable strain.
Ensure that plans are put into place to manage the costs associated with growth and that the business grows in a way which can be sustainably managed. Also, weigh the benefits of new contracts to ensure that they are in the best interests of the business in the long term.
5. Improve Cash Collection
There are many easy ways in which cash collection can be improved. First and foremost, when dealing with cash collection ensure that invoicing is carried out promptly. In a busy organisation, administrative tasks may be delayed in favour of marketing or sales activities. However, prompt invoicing will help to ensure that positive cash flow is maintained. When invoicing, ensure all supporting documentation includes references and other required information. Make it as easy as possible for your client to settle your invoices.
It is equally important to dedicate time to cash collection. While some clients may pay promptly, it is vital to be aware of those that don’t, and that you follow up with them. Clients with whom the business maintains good contact are more likely to settle their invoices, meaning a reduction of late payments if time is invested in the relationship.