Updated: Nov 21
Effective cash flow management is essential for small businesses, as poor cash flow management is one of the primary reasons why many new small businesses fail within the first five years.
This goes down to the truth that cash is the lifeblood of your business.
Moreover, SMEs are the backbone of the economy because more than 90% of businesses belong to this category, but numerous challenges, including monitoring cash flows, can highly impact the business.
Therefore, if you are a small business owner, it's important to prioritize the financial health of your company.
This article will provide you with effective cash flow management strategies, focusing on how to generate positive cash flow.
How Cash Flow Works
Cash flow is simply defined as the movement of money in and out of a business.
It shows how much money is coming in from sales, investments, loans, and other sources, and how much money is going out for expenses, payments to suppliers, taxes, and other costs.
A positive cash flow indicates that your business is generating more money than it is spending, whereas a negative cash flow indicates that your business is spending more money than it is bringing in.
But this is not dependent on the revenue of your business.
Here’s what a sample cash flow may look like:
Examining cash flow statements can be time-consuming and exhausting, especially if you have a large number of transactions to go through. This is where graphs and charts come into play.
Check out this actual sample of a company’s cash flow:
By visually summarizing your cash flow data, you can quickly and easily identify patterns and trends in your cash flow that may not be immediately apparent when looking at the raw data.
A line graph, for example, can show you the overall trend of your cash flow over time, allowing you to see if it is generally increasing or decreasing.
Why Profit Does Not Guarantee A Good Cash Flow
As mentioned, cash flow is even more crucial than revenue or profit, but here's the twist: your business profitability does not guarantee good cash flow.
Why? Because positive cash flow indicates that a company's liquid assets are increasing, while profit is closely related to taxable income.
At the bottom of your company's income statement, profits are reported as the difference between revenue and the cost of goods sold and other operating expenses incurred during the accounting period.
You can have a profitable business but still experience cash flow problems if the cash coming in is delayed or not enough to cover expenses, leading to a cash flow shortfall. This situation can occur when customers delay payments or inventory moves slowly, leading to excess stock that ties up cash.
It can also happen when the business has high debt payments or other fixed expenses that impact cash flow. Therefore, while profits are essential for the long-term sustainability of the business, cash flow is critical for day-to-day operations and the immediate financial health of the company.
The Importance Of Cash Flow For Small Businesses
Monitoring your cash flow is crucial since it represents the overall financial success and health of your business, which goes beyond just the revenue or profit figures.
When considering the bigger picture, the importance of having a positive cash flow becomes even more apparent. Without it, you cannot pay for expenses or inventory costs that could potentially generate more income.
Essential costs like rent, utilities, and other expenses cannot be paid either. A negative cash flow would cause your business to stumble and would be unable to sustain its operations, leading to accruing debts.
8 Strategies To Manage Your Cash Flow
It's completely understandable to struggle with keeping things on track, especially if you've just started your business. After all, you need cash to invest and sustain your business.
However, it's important to remember that the key to sustaining your business is to learn how to manage your cash flow effectively and create a solid strategy to avoid cash shortages.
Managing cash flow is an ongoing process, and it's essential to learn tips and strategies for developing an effective cash flow management plan.
Whether you're a small business owner or the CFO of a large corporation, here are valuable insights on how to manage your company's cash flow effectively:
Develop a Cash Flow Forecast
Actively forecast and plan ahead
You can prepare for anticipated inflows and outflows and gain a better understanding of the financial health of your business by forecasting your cash flow. You can use a cash flow forecast to determine whether you have enough money to pay bills, invest in new opportunities, and handle shortfalls.
Additionally, this can also assist you in identifying potential cash shortages, making plans for upcoming expenses, and making wise investment and financing decisions. As a business owner, you should always understand how a dollar spent today affects your position 1, 3, 6 or even more months down the road.
You can use a system to build a cash flow forecast or, more commonly, build on it in Excel or Google Sheets. No matter what you use, the key components of a cash forecast are:
Up-to-date bank ledger balances. In a crunch, you can use your bank balances, but your accounting ledgers, if up-to-date, will give you a true balance if you deal with outstanding items like checks.
Current accounts receivable (A/R) detail. If you carry A/R, you should understand your customers’ payment habits and timing. Do they send checks? Do they consistently pay two weeks behind or early? Knowing this, you can then forecast a reasonable estimate of collections that feed into your cash flow.
Current accounts payable (A/P) detail. Understanding your total payables is key to helping control money out the door. Perhaps you know you have more leniency with certain vendors to push payments out occasionally, or there are some vendors or contractors who will stop services immediately upon becoming past due with them. The rule of thumb is to pay your vendors, suppliers, and contractors by their due dates but not earlier unless there’s an incentive. Your cash flow forecast should show an estimated time of payment for all your bills.
Inflow and outflow assumptions & projections. Whether you have monthly recurring revenues (MRR) or completely random sales from customers, you should look for a revenue trend. Forecasting MRR is easy to do since customers typically have a certain day of the month for payment and might be on autopay. If you’re in more of a B2C revenue model, you should look for trends such as daily or weekly average deposits, month-over-month growth/decline rates, and seasonality, to name a few.
The same is true for expenses. It’d be smart to build a labor forecast that shows every W2 employee's and contractor’s cost forecasted out per their payment frequencies and costs. Web services and software can be itemized sometimes to show their costs and timing since many are on monthly, quarterly, or annual terms. Other costs can be more or less budgeted for by looking at historical average spending. Make sure to add a section for loans and other liabilities that you might be committed to.
Lastly, you should always be conservative with your assumptions and projections. This tool isn’t for raising money. It’s for running your business responsibly. Your degree of confidence should be very high when using projections. Overestimate expenses or underestimate revenue if your degree of confidence is low. You'd rather be prepared for the worst but hope for the best any day of the week.
A summary forecast. The cash flow forecast should take all of these components, which often might be done in sub-models, and create an easy-to-view summary that shows either week over week or month over month over a period of 6 to 12 months. Set up red flags and look at intracompany bank accounts and credit card balances. If you’re able to attribute all your inflows and outflows to an individual bank or credit card accounts, then you can see if those accounts ever reach a critically low balance or credit availability. You should be able to identify any critically low balances at least six months in advance to be able to react.
Monitor and Review Cash Flow Regularly
Actively monitor to understand your operations
Keep track of your cash flow on a regular basis, such as weekly or monthly, to spot problems early. Regular reviews could help you identify any unexpected expenses, changes in revenue, or other factors that may have an impact on your cash flow.
We often recommend doing cash flow updates every Monday. It’s a smart decision to make your bill pay, collections, and cash flow management a weekly process that all starts at the beginning of each week.
Don’t process bill payments blindly. Instead, do your collections first so you understand what inflows are likely for the week. Then update your cash flow forecast and determine what outflows are safe for the current period. Then process your bill payment.
Establish a Cash Management System
Check all balances individually not as a whole
Create a system for managing your cash flow that works for your business. This could include procedures for invoicing, tracking payments, and managing expenses.
Your team should have designated roles that oversee these processes. Keeping your accounting system up-to-date is essential to keep a good pulse on your cash flow.
Keep track of Receivables and Payables
How to know how much more cash you need till you're breakeven
Keep a close eye on your accounts receivable (what customers owe you) and accounts payable (what you owe to vendors). You should have a good understanding of customer and vendor habits, terms, and payment trends.
Make sure you are collecting payments from customers on time, and that you are paying your bills on time to avoid late fees and penalties. Collections are an essential part of any business that invoices and offers payment terms. It can be a pain sometimes to ask people for money, but collection is one of the most essential functions of a business.
There are companies and lenders out there that will buy your receivables, lend based on invoices, or offer invoice factoring. This is a strategy that could help get your cash in the door sooner while still satisfying your customer with your offer terms.
As mentioned, do not pay your payables early unless there’s a reasonable incentive.
Keep Expenses Under Control
Awareness is everything, especially with expenses
Monitor your expenses and identify areas where you can cut costs. This could include negotiating better prices with vendors, reducing unnecessary expenses, or finding ways to streamline processes to save time and money. It’s also a great idea to have a team-wide purchasing request process so that team members can’t just purchase whatever they want, whenever they want. Lastly, a company or even department budget is a great tool for accountability.
Negotiate Better Payment Terms with Vendors
Options to get it and how to position/prepare yourself for difficult conversations
Negotiate payment terms with vendors that work for your business. This could include longer payment terms, discounts for early payments, or installment payments.
This is a lever that can help buy you time. For instance, if you can negotiate net 60 or 90 payment terms with a supplier, that can give you the opportunity to sell enough of your stock to pay those suppliers from product sales within that time frame.
Obviously, that’s a big deal and very beneficial compared to when a supplier makes you pay 50% upfront just to ship it. Now that money comes out of your bank vs. from sales of the supplier's inventory.
Utilize Idle Equipment: Sell or Lease
Don’t let investments sit unused
If you have equipment or assets that are not being used, consider selling or leasing them to generate cash flow. This could include selling unused inventory, leasing out equipment, or renting out unused space.
Consider Hiring an Accountant for Financial Management
Existing tools do a bad job sometimes
Hiring an accountant can help you stay on top of your financials and provide valuable insights into your business's cash flow. An accountant can help you develop a cash flow management plan, track expenses, and identify areas for improvement.
The Impact Of Cash Flow Management On Your Business' Future
Poor cash flow management can lead to a variety of problems that may negatively impact your business.
For example, if your business is unable to pay bills on time, it could impact relationships with suppliers who may refuse to work with you in the future. Long-term cash deficiencies eventually lead to going out of business.
Late payments can also harm your company's credit score, making it more difficult to obtain loans or other forms of financing in the future.
Effective cash flow management, on the other hand, can help your business during difficult times and capitalize on opportunities for growth.
In fact, having a clear understanding of their cash position can help businesses make informed decisions about when to invest in new projects, hire new employees, or expand their operations.
To wrap it up, keep in mind that proper strategic planning is necessary for your business, especially when it comes to managing your cash flow as it directly affects your business's growth. Negative cash flow can hinder your business's continuous growth.
To avoid such issues, seeking professional help to monitor your cash flow is recommended. If you require consultation from an excellent accountant, we are here to help you. Compass CPA PC offers services tailored to our client's accounting needs.
Make your business journey convenient and great by booking a call with us today!