Unfortunately, most startups experience cash flow problems at one time or another. In some of these cases, cash flow problems could have been prevented if the business owner had taken some steps ahead of time.
Below, find six ways that you can improve your cash flow and prevent future problems.
- Invoice properly and use an acceptance letter
A good cash flow starts with proper invoicing. If you work with commercial clients, your work or product is probably sold using a contract. Contracts, especially those of larger businesses, usually have a clause that describes how and when to invoice. In many cases, the clause also states what backup documentation must be submitted.
It is critical that you follow the process outlined in the contract to the letter. Many companies, large ones especially, delay paying invoices if invoices are not submitted through proper channels or with the right backup materials.
Additionally, consider having your client sign an acceptance letter. An acceptance letter simply states that your client has received your products or services and is satisfied with them. This letter can be used in your collections efforts if there is ever a dispute.
- Improve collections
Collections is one of the most important functions in your business, as it brings the cash in. However, it is often treated as a secondary task that gets attention only when there are cash flow problems. Create a collections system and follow it regularly.
Once you have sent an invoice, backup documents and acceptance letter, contact the recipient to verify they were received. Many invoices are delayed simply because the accounts payable department never got them.
Contact your client if an invoice goes past due by more than ten days. Try to negotiate a new payment date. If they miss that date, repeat the process. If that effort fails, consider using a collections attorney.
Lastly, if there is a payment dispute, determine if it is bona fide. If the dispute is legitimate, fix the problem, as your reputation is at stake. If the dispute is not valid, use the acceptance letter as proof that you delivered according to the contract.
- Offer credit terms carefully
One of the easiest ways to encounter cash flow problems is to offer net-30 terms to companies that have no credit or a track record of paying late. You can avoid these clients by reviewing their commercial credit before making the sale. Commercial credit reports are available from Dun & Bradstreet, Cortera and Ansonia. Most credit reports are fairly easy to review and are self-explanatory. Here is a short tutorial on how to review commercial credit.
- Ensure that your pricing covers your costs
Ensure that your pricing is sufficient to cover all your costs and generate a profit. This rule may sound obvious. However, small businesses sometimes forget this rule in competitive situations. Consequently, they enter bidding wars and unknowingly bid below their cost. This approach is a surefire way to get into a financial tailspin.
Many companies price items below cost simply because they don’t know the exact “all-in” costs for their products and services. Depending on your type of business, determining the “all-in” cost can be a simple exercise, or it may require the help of your finance team (or a CPA). Once you have determined this cost, avoid bidding below it, and reprice/discard any items that generate a loss.
- Consider financing your accounts receivable
Some companies suffer financial problems because they can’t afford to offer net-30 to net-60 terms to their clients. Unless you have a reserve fund, offering terms drains your resources and could lead to cash flow problems. These problems usually get worse if your company is growing rapidly. One solution is to finance your accounts receivable (invoices) using accounts receivable financing. This strategy provides an advance for your slow-paying invoices and improves cash flow.
- Build a reserve fund
Building a reserve fund is a good way to avoid future cash flow problems. It is simple to do, but it requires discipline. Divert a small portion of your profits every month to a reserve bank account. Build this account until it reaches a level that you are comfortable with. Don’t touch this account unless the company is experiencing cash flow problems.