As Indians, we all know about those thick-bound ledger books used to maintain business accounts in the old days before computers and digital transactions replaced them. Just as they were a vital part of business growth back then, managing accounts still remains a key element of business development and stability even today. As a small business owner or entrepreneur, it is crucial for businesses to monitor their cash flow on a regular basis.An imbalance of cash flow can cause businesses to go bankrupt even if they are making profits on paper. This handy guide will explain how to manage cash flow in a small business successfully.
Basics Of Cash Flow Management
Cash Flow: Cash flow refers to the movement of money in and out of your business in terms of income and expenditure. Cash flow management is the process of tracking how much money is coming into and going out of your business and to make sure there is enough money to keep the business running.
Positive Cash Flow: This occurs when the cash entering into your business from sales, accounts receivable, etc. is more than the amount of the cash leaving your businesses through vendor payments, monthly expenses, salaries, etc.
Negative Cash Flow: This occurs when your outflow of cash is greater than your incoming cash. This generally means trouble for business and will require reducing expenses.
Cash Flow Statement: This is similar to a profit and loss statement and the balance sheet. Its aim is to look at how cash moves in and out of the business and gives you a ‘Net Cash’ figure. It divides cash spent or received in the following categories: Operating, Investing, and Financing activities.
5 Ways To Fix Cash Flow Issues
1. Speed Up Account Receivables
The easiest way to get to positive cash flow is to receive cash at the earliest. Invoice your customers immediately after the service or product has been delivered. Design your invoices so they’re straightforward and easy to read, with key areas like due date, the amount due, where to send payment and payment methods highlighted. Speed things up further by emailing invoices instead of mailing them. Follow up with clients with long-overdue accounts to recover the amount due. You can also provide discounts for early payments. Use an invoicing system to auto-generate invoices and give customers multiple options of payments to ease up the transaction.
2. Delay Payments
Any business has multiple payments to be made like rent, salaries, vendors, and other business expenses and requires managing cash flow. Unless there is an incentive to pay your dues early, choose to pay your vendors as late as possible without risking late fees or harming the relationship. This will make sure you have cash available in your accounts for other urgent payments until more cash comes in. You can also negotiate terms with vendors to include a delayed payment structure for larger order quantities or discounts for early payments. This will overall reduce your negative cash flow.
3. Liquidate Assets
Excess inventory can tie up cash and also result in increased costs due to storage expenses. With customer requirements constantly changing, one can choose to either sell or dispose of excess inventory to reduce costs. Similarly, if your business has any equipment that is idle or obsolete, selling it could generate quick cash. Equipment that has been owned for a longer period will usually have a book value equal to its salvage value or less, so a sale might result in a taxable gain. If you have to sell below the book value, however, you will incur a tax loss, which can be used to offset other profits of the company.
4. Short-Term Financing
Many businesses opt for short term financing like a line of credit from the bank for an emergency purchase or to bridge the gap between payables and receivables. You can also opt for business credit cards to make payments to vendors and also use the reward system for points to be redeemed for business travel or business purchases.
5. Long-Term Loans
To make managing cash flow and working capital easier choose to finance purchases of large assets like equipment and real estate using long term loans instead of using your working capital. This allows you to spread the payments over the average life of the assets. While there is an additional expenditure of interest, you’ll have preserved your working capital for business operations. Alternatively, you could choose to lease vehicles, computers, and other business equipment that avoids tying up cash and yet allows you to expense them as costs on your business taxes.
Tips To Manage Cash Flow Effectively
1. Monitor Your Inventory
Analyze your inventory movement to determine which items are fast-moving and which ones are not can help in managing cash flow. Try to keep lean inventory levels so that your cash isn’t tied-up unproductively and unprofitably. For example, if you suddenly receive high demand for a product, it’s tempting to order a high volume of material to service that demand. However, if that demand then changes you could be left with far too much stock and, potentially, debt from ordering the materials. Ordering too much stock might also leave you lumbered with materials that become obsolete and difficult to sell.
2. Cut Costs
When the business starts to make profits, we tend to ignore cost-cutting opportunities and may also go on a spending spree for business requirements. Unmanaged negative cash flow is a silent killer for business. Always be on top of your expenses and figure out methods to reduce or eliminate costs. Companies that operate in a lean fashion are better able to withstand economic shocks.
3. Ask For Deposits Or Advances
In case of large orders or long-term contracts, choose to ask for a 10% deposit or advance at the beginning of the job. You can choose to receive payment based on milestones completed as this will bring in regular cash flow and help you in paying expenses instead of a lump-sum amount at the end of the project which can cause cash flow management issues.
4. Identify Business Risks
Preparing in advance requires one to assess all the potential risks to a business. Identify potential scenarios like delay in payment by a huge client, a huge order got cancelled, etc. Figure out which cash inflow or outflow in the coming months are crucial to positive cash flow. By continuously monitoring your cash flow statement, one can avoid pitfalls and continue running the business successfully.
5. Keep Buffer Money
One must know the amount of working capital one needs to keep the business running. It is a prudent idea to keep 1-3 months of your working capital needs saved up in case of emergencies. You can do this by keeping your cash balances in an interest-earning account or invest in safe fixed deposits. Lastly, one can arrange for overdraft or revolving credit facilities with their banks.
- Prepare a monthly, quarterly, or yearly cash flow statement
- The net cash flow after adding up the cash inflows and outflows determines the current cash available
- If there is excessive cash available, transfer them into a savings account or pay off vendors earlier
- If there is negative cash flow, delay payments and offer discounts to receive accounts receivable at the earliest
How to manage cash flow does not have to be a tricky problem and is key to a successful business. Without cash, profits are meaningless. Profitable businesses are forced into bankruptcy because the amount of cash coming in doesn’t compare with the amount of cash going out. Firms that don’t exercise good cash management may not be able to make the investments needed to compete, or they may have to pay more to borrow money to function. Hence, don’t let a few cash flow missteps put you in a money crunch.