A guide to small business cash flow management

Popular culture and the news media encourage us to think about business health mainly in terms of profit and loss rather than cash flow. For example, TV and newspaper reports give us these numbers and little else when covering major companies’ quarterly results. More generally, the word ‘company’ is often prefaced with adjectives like ‘profit-driven’ or ‘profit-seeking’ as opposed to ‘non-profit’ or ‘not-for-profit’.

As such, when starting a small business it’s understandable that many entrepreneurs fixate on this aspect of their finances. But when it comes to SMEs and startups, most experts believe achieving a healthy cash flow is by far the more important challenge.

This guide to small business cash flow management will take you through the basics of this vital aspect of maintaining financial health. After that, we’ll move onto some tips and advice.

What does cash flow mean in business?

Cash flow is the difference between the amount of cash (‘liquidity’ or ‘liquid assets’) available to your business at the beginning of a period and the amount at the end. It’s not unreasonable for a small business owner to think of cash flow simply as how your business activities affect the amount of money in your bank.

Since the 1980s, the phrase “cash is king” has become ubiquitous . Events like the 1987 Stock Market Crash, the 1997 Asian Financial Crisis and the Global Financial Crisis of 2008 saw many businesses fail even though they could demonstrate a positive net worth. Bulging order books and even considerable asset wealth could not by themselves save these companies from collapsing. The sad truth is that many businesses fail simply when they lack the cash to pay the bills.

For small businesses, cash tends to be especially important, partly because access to credit is generally more restricted than for larger firms. Still, organisations of all sizes can fall victim to cash flow crises.

What is a cash flow statement?

The purpose of a cash flow statement is to record the amount of cash entering and leaving an organisation. It shows how changes in your balance sheet and income statement affect your liquidity.

A cash flow statement is broken down into three components: operating, investing and financing activities. These can all affect the cash coming in and out of the business. Operating activities cover the costs of producing your product or service and the sales you make. Investing activities are, as the name suggests, related to purchasing and selling assets, providing credit to customers (or receiving it from suppliers) and the acquisition of other companies. Finally, financing activities involve inflows of cash from loans and shareholder investment, as well as outgoings in the form of dividend payments.

Common cash flow problems small businesses face

Now you know something about the theory, it’s time to move onto practicalities. Here are some of the cash flow problems to look out for. Simply keeping them in mind from the outset can be a big help to small business owners, as you can deal proactively with problems before they become too severe.

Slow or late-paying customers

The bane of many a small business owner’s life, slow or late paying customers (not to mention those who never pay up at all) can make self-employment a real headache. In this next section we’ll look at some ways to deal with this common problem.

While we’re on the topic of slow payers, another reason to keep an eye on cash flow is that by running low on liquidity you could be forced to pay suppliers late yourself. You could therefore end up putting other small businesses under the same pressures that make your own life difficult. Avoiding this is important for ethical as well as financial reasons.

High overhead expenses

When it comes to small business overheads, home-based outfits and mobile service providers can have a significant advantage over those with substantial premises. It’s no coincidence that many successful businesses started out as back bedroom or garage-based operations. They only moved into offices, warehouses, workshops, factories or stores when the time was right.

The rent, lease or mortgage on your premises are examples of a fixed overhead cost. A good example of a varying cost is the expenses involved in mailing products for an online retailer. These costs will increase with the size, weight and quantity of items sold.

Funds tied up in stock or equipment

Retailers have to make a judgement call in terms of the value of stock they hold. Similarly, tradesmen have to choose when to invest in their own equipment and when to hire tools on a job-by-job basis.

It’s tempting to focus purely on direct costs when making these kinds of decisions. In the publishing world, for example, it’s far cheaper per-unit to print high volumes of books when compared with printing on demand. So to many newcomers, the choice might seem simple. In fact, many experienced small publishers opt for print-on-demand, simply because it helps them hold onto their cash.

Insufficient margins

In sectors and locations where competition is high, small business owners have to keep their quotes down in order to secure work. In some cases, it’s possible to find an upmarket niche that keeps you out of any races to the bottom. But ultimately nobody is exempt from the laws of supply and demand.

You may find yourself charging too optimistically, reducing your margins to a point where you break even or potentially lose money. This can quickly lead to a cash crisis.

Seasonal sales fluctuations

Hotels and B&Bs, for example, have to make enough money in the summer to see them through the entire year, while many retailers rely on the Christmas trade to carry them through their leaner months. It can take a couple of years to get to know how your sales are likely to ebb and flow throughout the year. The temptation is to assume the good times will last forever, particularly before you have the experience to take a more realistic view.

How to effectively manage your businesses cash flow

So much for the problems - what should you do about them? Let’s look at some simple ways to improve small business cash flow management.

Invoice on time and monitor payments

If your business involves invoicing, it’s imperative that you bill your customers punctually and keep an eye on all debts. If you don’t want to invest in any software to help you handle this job, you can use the calendar app on your smartphone. Set reminders to nudge you when it’s time to chase payment.

Give discounts to quick payers

Give customers a 5% or 10% discount for paying within a week, 10 days, or your preferred period of time. By doing this, you could find that late payments become less of an issue over time.

Keep costs down

This isn’t something that wouldn’t have occurred to you, but it’s still important to be constantly on the lookout for new ways to save cash. If you use a lot of software, for example, you’ll notice that increasing numbers of programmes are available on cloud-based, subscription models. This includes Microsoft Office, Adobe Creative Cloud and several accountancy packages.

Monthly payments can end up costing you more over the years, but as we’ve seen that shouldn’t be your only consideration.

Offer fixed payment plans

Does your pricing structure lend itself to generating a healthy cashflow? Ideally (and this unfortunately won’t be possible for many businesses) you’ll want regular, predictable payments coming from your customers every month. Could you offer a subscription model? Let’s say you run a nail salon, for example - could you offer a certain number of treatments per month for a discounted price? Taking payment by direct debit is ideal if possible.

Get rid of excess inventory

Unsold stock will depreciate in value, so get rid of it quickly to generate as much liquidity as you can. As a retailer, you can do this with end-of-season sales, discounting online or selling in bulk to another trader.

Get credit before you need it

One of the well-known ironies of financial management is that if you want credit, you’ll need to convince a lender that you don’t need it. Banks are often willing to provide overdraft facilities and credit cards to small business owners at the time they open their accounts. It can be worth taking them up on these even if you have no intention of using them. If you do find yourself in the midst of a cash crisis, you could find it hard to secure the funds to bail you out.

Invoice factoring

Some small business owners may be able to take advantage of invoice factoring. This involves essentially selling your invoices to a third party. They will give you the cash owed minus a percentage, and then they’ll receive the funds when the invoice is paid. Again, invoice discounting will have an impact on your profit margin, but this may be offset by your increase in liquidity.

We have created these tips and advice pages to help you run your small business as effectively as possible.

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