If you are among the enterprising individuals in the process of launching or running your own business, this article is for you. You may already have your hands full with operating activities, staffing and continually improving return on investment (ROI). Now, if you could just wrap your head around this cash flow advice and apply it to your labor of love, the chances of making your venture a success will become that much more realistic.
What is cash flow?
Cash flow refers to the money that passes in and out of your business from operating, investing and financing activities. It’s the amount of liquid cash you have on hand at a given moment in time.
It’s different, and arguably, a more important figure than profit (more on this later).
What you and your stakeholders want to see is positive cash flow (i.e. your cash inflows are greater than your cash flows), which indicates the day-to-day stability of your operation.
Why cash flow management matters
While profit provides a high-level overview of how a business is performing, it doesn’t give an accurate evaluation of your ability to meet current and near-term expenses that are critical to day-to-day operations.
Most businesses use the accrual method of accounting, which records income and expenses when you earn or incur them — regardless of whether or not you’ve actually received the money.
However, not all profit and losses are instantaneous, and if you’re working with Net30, Net60, or Net120 terms, your profit will look significantly different than your cash flow — which can land you in a situation where there’s not enough liquidity to keep the wheels running.
Let’s explore an example of why the flow of cash is critical to note.
Say you own a clothing business and land a huge contract with a department store that wants to purchase $25,000 of products from you. To determine your total profitability, you need to know your gross profit, which will help you calculate your net profit.
Revenue – Cost of Goods Sold (COGS) = Gross Profit
$25,000 – $12,000 = $13,000
However, your gross profit doesn’t take into consideration all of the additional operating expenses that are involved in running your clothing business; for example, the cost of rent, payroll and online advertising.
Gross Profit – Operating Expenses = Net Profit
$13,000 – $5,000 = $8,000
Factoring in your operating expenses, your net profit is $8,000, which is great — on paper.
But what this number fails to articulate is that the $25,000 payment comes with terms of NET90, meaning you won’t actually receive the cash from the sale for another 90 days. See the difference?
Four quick cash flow management tips
Business owners can use the following tips to get a handle on their cash flow, and overall money management practices. Check out these four simple cash flow management tips and apply them to your strategy today.
Tip #1: Perform a regular cash flow analysis
Preferably, you should perform a cash flow analysis at least once per month. This will help you identify trends in ebbs and flows with your cash flow and make more realistic projections for your cash situation moving forward.
- Determine the time period to analyze
- Prepare your cash flow statement
- Enter your business’ total cash balance at the beginning of the time period into your spreadsheet.
- Create inflow (+) and outflow (-) columns for three categories: Operating Activities, Investment Activities and Financing Activities
- Record all relevant activities for the current period
- Add everything up (total inflows – total outflows) to arrive at the closing balance
Your aim is to see a higher closing balance at the end of each period than the beginning balance, which indicates a positive cash flow.
Tip #2: Rework payments terms
Are your payment terms working in your favor?
Here are some strategies you may want to consider implementing to make operations run more smoothly:
Get customers to pay faster
Ideally, you will be able to collect money from your clients before you have to pay your suppliers or vendors. However, this isn’t always possible. That being said, there are ways to get your clients to pay up faster, including:
- Renegotiating payment terms: If you typically give customers 45 days to pay, consider cutting it to 30 days, or even 15 days. Just make sure you give notice before making any drastic changes.
- Incentivize customers to pay earlier: Offer “a carrot” to your customers by giving them a small discount if they make payments early.
Make it easier for customers to pay
Implement convenient ways for your customers to pay you. There are a number of fintech solutions that can help automate monthly payments and better track accounts receivable. Consider setting up an online payment system that makes it easy for clients to pay you in just a few minutes, from their desktop or mobile device.
Pay your suppliers and vendors later
If you normally pay your suppliers and vendors within 30 days but find yourself repeatedly encountering the same cash flow problems, see if you can extend your payment terms to 45, or even 60 days. An extra 15 or 30 days may seem unimportant, but it could provide you with some much-needed wiggle room.
Negotiate discounts with suppliers and vendors
Building good relationships with suppliers and vendors can pay off in many ways. One of which might be getting better deals on supplies. If you’re buying certain items in bulk, see if they’d be able to offer you a small discount on these larger purchases.
Tip #3: Identify money leaks
According to American Express, the six most common areas for business money leaks are employee salaries, rent, “small stuff” like coffee and office supplies, internet and phone service, and operational expenses such as paying highly-skilled staff for entry level work.
So, when looking for money leaks, start with this list and identify if there are any areas for savings. Additionally, look for any non-essential expenses that you can cut for the time-being. Keep in mind that saving even small amounts can increase your cash reserves a significant sum in the long run.
Tip #4: Consider alternative funding
There are a number of borrowing options available to free up your cash flow, providing you with a cash cushion to tide you over, as well as giving you room to explore ways to boost your revenue streams, cash flow, and ultimately your business. Even if you’re not in a cash flow crunch, you may not feel comfortable draining your cash reserves to make a long-term investment in business growth. This is where business funding can lend a helping hand.
Many business owners use credit cards to make purchases, but if you’re only making minimum monthly payments, or have an outstanding balance, this could cost you. Take the time to review the interest rates on your various business credit accounts, and consider your options for business debt consolidation. Consolidating multiple debt products into a single, monthly payment can make payments more manageable, and in some cases save your business thousands of dollars if you’re able to land a lower interest rate.
Consider longer-term forms of financing like term loans or SBA loans. These tend to come with lower monthly payments, which means you’ll have more cash you can be put toward necessary operating expenses.
Now, you understand what cash flow is and why it’s important to look at more than just business profits and losses. You have an idea of what steps you can take to start seeing more gains from your operations. Apply this advice today and watch your entrepreneurial success skyrocket.