Naturally, business owners are highly-focused on generating profits. They assume that if their business is showing a profit, they’re headed for smooth sailing.
However, a new study shows that it’s cash flow issues, not profitability issues, that cause 8 out of 10 business failures.
You see, without enough cash flow, you’re more likely to feel the squeeze of even a minor or temporary cash shortage. Such a shortage could crush your ability to make essential purchases, pay your suppliers, and even pay your employees.
Cash flow management is critical for managing a successful business. Proper cash flow management ensures the availability of working capital, which enables you to:
- Continue operating your business – even when life throws you a curveball from time to time
- Maximize cash on hand, so you can put that cash to work for your business
- Invest in the business through new technologies
- Pay down debt
So let’s dig in and look at 5 ways you can begin managing your cash flow more effectively.
Step 1: Understand what cash flow management looks like
Your sales team might have a monster quarter. Profitability might look full of potential. But keeping the doors open is all about the cash flow.
Profit is the amount of income you’re left with after you pay all your expenses. Cash flow, just like it sounds, represents the net flow of cash that came into and went out of your business.
The two might sound the same, but profit is largely theoretical in nature, while cash flow is more tangible.
Imagine Small Business XYZ sends a bill to a client. The CRA requires small business owners to report income and expenses using the accrual method of accounting. So XYZ records the income at the time they generate the invoice rather than when they receive the cash.
However, you know all too well that most clients don’t pay you the same day. Many will pay 30, 60, or even 90 days later.
So your real-time cash flow situation is quite different than your P&L statement indicates. As a result, you could find yourself without enough cash to keep your company running if you’re not monitoring and managing your cash flow.
Effective cash flow management involves encouraging customers to pay invoices as quickly as possible as well as delaying outlays of your own cash as long as possible.
Step 2: Use effective strategies to measure and manage cash flow
Some reports estimate that 90% of small businesses operate without a cash flow plan. The same businesses may have profit margin forecasts – 3, 5 and even 10 years out. But without a cash flow plan, the business is flying blind.
When cash starts rolling in and the business turns profitable, it can be easy to ignore cost management opportunities. But this kind of unmanaged cash outflow is a leading cause of death for small businesses.
There’s a saying that if you fail to plan, then you plan to fail.
Don’t let that describe your business. We can’t say it enough. Cash flow management is absolutely critical. And healthy cash flow doesn’t just happen.
To actively manage cash flow, first you have to measure the cash that’s coming in and out of your business. This will help identify where you stand with cash flow today.
From there, identify where you need your cash flow to be. You can determine the ideal scenario by understanding what kind of working capital is necessary to effectively run the business. To quantify these numbers, begin asking questions like:
- How much do our customers owe?
- How many overdue invoices are out there? How long are we waiting on these payments?
- Which clients are chronically late payers?
- Which clients are reliable payers?
- How much inventory do we really need to have on hand?
- How much of our cash is tied up in work in progress?
- How much does the business owe to suppliers?
- How do we determine when we pay our suppliers?
- How many fixed costs does the business have? How many variable costs?
Once you’ve got a handle on this kind of gap analysis, you can take action and develop a cash flow management plan. In this plan, outline how you’ll resolve any negative variance between outgoing and incoming cash flow.
Step 3: Expedite collection from your customers
Many small businesses wonder how they can encourage customers to pay on time and still maintain a positive working relationship.
- First, make it as easy as possible for your customers to pay you. For example, is there a payment link on your invoice so customers can pay with a credit card? The easier it is to pay, the more likely the customer will pay the invoice upon receipt.
- Send clear invoices and send them early. Control what you can control. Bill clients as early as possible. Be sure invoices are clear and detailed to avoid delays.
- Invoice progressively where it makes sense to do so. For a large order or project, ask for a deposit and then bill in stages throughout the project.
- Stay on top of overdue accounts. Design and deploy procedures to follow up on all unpaid invoices. When customers know you’re on top of your billing, they are more likely to pay on time. The opposite is also true.
Step 4: Manage vendor relationships
It goes without saying that you should nurture a solid relationship with your suppliers. They might be more willing to work with you when you need to manage payment terms.
One part of managing cash flow is keeping as much money as possible – for as long as possible – in an interest-earning account. One way to do this is to determine how late you can pay your vendors without damaging the relationship or incurring any fees.
Digital banking makes it easy to set up automated direct debits to pay expenses on the actual due date.
Step 5: Talk to your bank about short-term debt financing options
Your bank is another place where you want to have strong relationships. A bank will be more inclined to lend to your business if you have a solid relationship as well as a solid track record.
Short-term financing, such as a line of credit, can help during those lean periods when you need to make emergency purchases or bridge the gap between your payables and your receivables.
Look for attractive interest rates and payment terms that make sense for your situation.
There are many ways small businesses in Canada can manage and optimize cash flow. Whether the business is based in Alberta, or elsewhere, it’s in your best interest to dig in and explore the options available to you.
The DIY route may have worked with your personal finances, but keeping your business in a good cash flow position is far more complicated. Involving a qualified certified public accountant will free up your time and ensure you have enough cash on hand to meet financial obligations and keep growing your business.