When you own a small business, your cash flow and how you maintain it is extremely important. Dealing with a cash flow crisis may require you to make serious budget cuts or sell assets. For example, you may need to quickly sell a company vehicle to try and maintain positive cash flow or lay off employees.
Below, we cover some of the things every business owner should understand about cash flow, how to avoid a crisis, and what to do if you find yourself in a tough spot.
What is cash flow?
Cash flow refers to the net amount of cash and cash equivalents transferred in and out of your business. The cash received is your entry. What you spend are your outings.
By monitoring your cash flow, you get an idea of what’s coming in versus what’s going out and if you have a deficit.
If you have more than enough cash in your business account to cover all of your bills and expenses, then your cash flow is positive. If your expenses are more than what you get, you’ve got a problem.
Two terms you should familiarize yourself with here are accounts payable and accounts receivable.
Accounts payable are a liability account that tracks what leaves your business – money you owe. Accounts payable can include payroll, loans, and other business expenses.
Accounts receivable is an asset account where you follow the money that comes to you, for example, from your customers.
A third relevant term is your profitability. Your profitability is determined by adding up all of your assets and then subtracting your accounts payable. If you get a positive number, you have a profitable business. If the number is negative, you are not profitable. However, you should note that positive cash flow doesn’t always mean you are profitable.
You can also be profitable and not have cash on hand.
The importance of cash flow
One of the most critical elements in keeping your small business running smoothly is cash flow. Research shows that the most common reasons businesses fail are often because they don’t have enough cash on hand.
Along with having a positive cash flow, having the right cash balance is also essential.
If you are a startup or planning to launch one, you will probably need to have access to cash early in your setup. You might need to pay a website developer or a deposit for renting office space, for example. Because of these factors, it is not uncommon at first to see money coming out of your business faster than it is coming in.
As your business matures, this should stop.
Understanding a cash flow statement
One of the most important things you can do to avoid a cash flow crisis is to understand the technical aspects of cash flow itself.
A cash flow statement shows you how your money is coming in and going out. A cash flow statement will generally divide your business into three segments. There are operating, investing and financing flows.
Operating cash flow is any expense or income from your net income. The operating flow can include the purchase of goods and income from the sale of products or services. Cash flow transactions are a natural result of running your business.
Investment flow refers to your investments such as purchasing equipment that you can use in the future to improve your processes, profitability or efficiency.
The funding stream can include taking out a business loan or anything else focused on debt and dividends.
Your statement of cash flows is different from your statement of operations. Your income statement shows your financial performance during an accounting period. A balance sheet considers your liabilities and assets as a snapshot over a period of time. Your balance sheet can help you show you the financial health of your business at all times.
The main reasons for cash flow problems
Rather than trying to get by and make a quick buck by doing things you’d rather not, like selling assets, it’s good to be proactive. When you are a business owner, try to understand the common pitfalls of cash flow management so that you can take steps to avoid them and identify red flags that might arise in your business.
Some of the most common reasons for cash flow problems include:
- You spend too much at the start. We talked about the fact that at the start of your business you will probably have to invest it and you may also have to use your own money. Even so, you still have to be strategic. If you overspend on your start-up costs, you can put yourself in a tough spot in terms of cash flow. There are things that you should, if possible, defer purchasing until you are more stable in your business.
- Not keeping track of expenses is so easy to overcome, but so often leads to cash flow disasters. As soon as you start your business, you should have an accounting system in place to track income and expenses. Your accounting system can be as simple as a spreadsheet, as long as it allows you to see your expenses.
- When you are a business owner, you want happy customers. It can make it difficult for you to be firm when it comes to paying bills, but when you let customers delay their payments, it can end your business.
- If your business has seasonal elements that are relevant to the operation, you should always plan ahead. Even very successful businesses tend to experience low cash flow based on seasonality. Also, don’t spend too much of your personal money during these slack periods, instead consider working capital solutions.
- Inventory management is complex at the moment. Companies have slowed their orders during COVID-19, and now, as they try to restart, they are facing backlogs and supply chain disruptions. Even so, be as strategic as possible with your inventory management. If you have too much inventory, you won’t be able to sell it quickly enough to cover purchasing and storage expenses. At the same time, if you don’t have enough stock, you won’t meet the needs of customers and they’ll go elsewhere.
What if you are in crisis?
Even with careful planning and knowing your cash flow, you can still come to a point of crisis for a variety of reasons.
If you are facing a crisis, some of the options you can use to raise funds quickly include:
- Commercial Cash Advances: Merchant account companies and some digital payment solution providers will offer advances on your future card sales receipts. While it was once known to be very expensive and often worthless, conditions tend to be more favorable now. You can think of it as a working capital loan or maybe a line of credit. You get an advance, then you pay it back on your future sales. You have to pay a fee for the advance.
- Make adjustments to your business plan: If you are experiencing a cash flow shortage, you may need to review your business plan and your operations, processes, and expenses. Why is this happening and what can you do to prevent it from happening again? You might, for example, realize that you need to cut certain things and then focus on the most profitable services. You could end up dropping out customers who are more expensive than their value, or you could spot areas of waste.
- Accelerate Receivables: When you face cash flow issues, you need to get money into your business. You can ask customers for partial payments or deposits up front as a way to bring in cash rather than charging them the total after the product or service is delivered. You can send invoices earlier and more frequently and focus on overdue accounts. You should also make payment as simple and easy as possible for customers.
- Negotiate debts. Besides bringing in more money, if you think you have a looming crisis on the horizon, you can try cutting back on what’s coming out at the same time. Talk to your suppliers about what’s going on and see if you can delay payments or negotiate terms. There will be suppliers who are ready to work with you, although not all of them will.
- Cut your expenses: Every penny that leaves your business and your accounts should be something you are very aware of. You need to be particularly careful when there is a cash flow problem.
Finally, we talked about this above, but you could end up selling non-core assets. For example, you might have a commercial vehicle that you don’t need or a piece of equipment that you don’t use. It’s a quick fix, but sometimes it’s the best financial choice you have for getting cash fast.
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