Effective cash flow management is critical to the success of any small business. When you don’t have a lot of working capital, you may encounter some tight spots that could prevent you from paying salaries on time, buying materials or equipment when you need it, or paying your as promised. One of the biggest problems a small business owner faces daily is the time delay between when you must pay your bills and when you receive payment from your customers. The best solutions for this problem is effective cash flow management.
To be successful, you will need to keep enough working capital on hand to meet these delays in cash flow. We are going to dive into some effective strategies for managing and improving your cash flow in a moment, but first, you need to know some of the basics of cash flow management.
The Basics of Cash Flow Management
In the simplest of terms, cash flow is the movement of money in and out of your business. You should track your cash flow monthly or maybe even weekly, especially if you’re operating with a small amount of working capital. There are two types of cash flow:
Positive Cash Flow
Obviously, this is where you want your business to be. Positive cash flow occurs when the amount of money coming into your business is greater than the amount of money going out.
Negative Cash Flow
Negative cash flow means you have more money going out than you have coming in. It also means your business is in trouble and you need to act quickly with some of the strategies below.
Making a Profit Doesn’t Always Mean You Have Good Cash Flow
Even if your profit and loss statement is telling you that your company is making a profit each quarter, there are other factors that determine your cash flow, such as your accounts payable and accounts receivable. Profit is simply defined as your revenue minus your expenses. Successful business owners know that earning a profit is not the same thing as knowing where your cash is going.
Determine Your Breakeven Point
You should always know what point your business needs to reach to become profitable. This doesn’t affect your cash flow, but it does give you a target for projecting future cash flow. You’ll want to focus your cash flow management efforts on the goal of meeting and surpassing your breakeven point.
Calculate How Much Working Capital Your Business Needs
You can’t determine if you are managing your cash flow successfully if you do not know how much working capital your business needs. There are a lot of factors that will need to be considered when determining this, such as inventory, overdue accounts, and cash that’s tied up in work that is in progress. In the beginning, it’s best to bring in an outsourced business accounting service to help you anticipate the flow of money in and out of your business so that you know how much working capital you need to have to meet your financial demands.
5 Strategies for Fixing Cash Flow Problems
Now that we’ve covered the basics, let’s talk about some strategies that you can use to fix cash flow problems in your business.
1. Have Your Clients Make an Upfront Deposit on Large Orders or Jobs
If your business provides a service or product that requires a large output of cash upfront before delivery, ask your clients to pay a deposit upfront or have them make milestone payments while the job is being completed. This strategy gives you some working capital while the job is being completed.
2. Encourage Your Clients to Pay Faster
Getting your customers to pay faster gives you access to working capital sooner. One of the most effective ways to encourage faster payment is to offer a small discount of 2% if the client pays their invoice in full within 10 days on invoices that would normally be paid in 30 days. Many companies will be attracted to this option because they have a budget to stick to, just like you do. You should also consider utilizing online invoicing and invoicing sooner to help you get your clients to take action faster.
3. Sell or Rent Out Equipment That You Aren’t Using
Is there equipment collecting dust somewhere that you no longer need? Unused equipment ties up working capital that could be put to better use elsewhere. If you have an expensive piece of equipment that you are not using now, but you will need it in the future, consider renting it out to another business so that it can be bringing in capital while you’re not using it.
4. Pay Your Vendors as Late as Possible
This is a strategy that is often overlooked by business owners, but it could be a lifesaver if working capital is tight. Figure out how long you can wait to pay your vendors before a late fee is required. That way, you can keep that cash on hand to use for other things for as long as possible. If you have a good working relationship with your vendors, they may even be willing to negotiate more favorable terms with you.
5. Cut Your Expenses
You have probably already thought of raising your prices, but sometimes cutting your business expenses is a better option. There are many creative ways to accomplish this. Some ideas are selling off your existing inventory before making a new product or finding cheaper ways to manufacture your product. You could also consider downsizing or using freelance workers instead of having full-time employees on your payroll. When it comes to equipment, consider buying used and repair what you have on hand instead of buying new. The point is, you should review your expenses on a regular basis to see if there are places where you can cut back to reduce the amount of money going out of your business.
Your working capital is the fuel that powers your small business. It’s critical that you manage your cash flow properly to be successful.