You’ve heard it before: “Money makes the world go round.” That’s as true for global economies as it is for your corner store or digital startup. Managing cash flow is essential for maintaining a profitable and sustainable business.
Continue reading to learn more about what cash flow is and how to improve your small business’ profits.
What Is Cash Flow and Why Is It Important for Small Businesses?
Cash flow is the financial heartbeat of your small business, signifying the net amount of money and assets that circulate in and out of your operations.
Let’s break it down: “Outflows” refer to the money you spend. These are your operating expenses — everything from salaries and rent to utility bills and supplier invoices. On the other hand, “inflows” signify the funds you earn. These come from sales, accounts receivable and other income-generating activities like asset sales or investments.
That said, your company’s worth isn’t solely dictated by its revenue or even its net income. Instead, the spotlight is on your ability to consistently generate a positive cash flow and, importantly, maintain a long-term free cash flow.
But what does free cash flow mean? It’s the leftover money after you’ve paid off your capital expenditures — such as equipment or property costs — as well as your day-to-day operating expenses.
This remaining capital is what you have on hand to grow your business, be it through reinvestment, saving or distributing funds to shareholders or owners.
Now, why is robust cash flow management so pivotal? For one, it allows you to catch potential financial problems in their infancy. Suppose you notice a downward trend in your cash inflow or an unexpected spike in operating expenses. With effective cash flow management, you can address these issues promptly. And given that a Xero study shows about 9 out of 10 small businesses face at least one month of negative cash flow per year, this is not an area to overlook.
Moreover, knowledge of your cash flow also equips you for sound future planning. When you know the volume and timing of your inflows and outflows, you’re better positioned to make strategic decisions.
- Should you invest in a new product line?
- Is it the right time to hire more staff?
- Can you afford to offer more competitive payment terms to your customers?
These questions and more become easier to answer. Beyond short-term and long-term planning, understanding cash flow influences other financial aspects like your credit score, which plays a role in securing business loans or credit. It also affects your working capital, which is essential for daily operations and can influence how you approach payment terms with vendors or clients to maintain a healthy cash position.
Signs Your Cash Flow Needs a Health Check
When your cash flow is running smoothly, so are your operations. But if you’re experiencing certain symptoms, it’s time for a financial health check. Here’s how to spot the warning signs:
- Stagnant inventory: An increasing amount of unsold stock indicates slow sales and could point to upcoming cash flow issues.
- Delayed payments: If your accounts receivable age past their due date regularly, you’re missing out on vital cash inflow.
- Frequent overdrafts: If you find yourself frequently tapping into your overdraft protection, it’s a clear sign that your cash outflows are overtaking your inflows.
- Declining revenue: A sudden or gradual decrease in revenue should sound alarm bells for your cash flow situation.
- Rising debt: If you’re borrowing more to cover operational expenses, your cash flow is inadequate to meet your financial obligations.
- Missed opportunities: If you’re passing up beneficial opportunities like bulk purchasing discounts because of low cash reserves, you’re likely compromising future growth prospects.
External Factors Affecting Cash Flow
Sometimes cash flow issues aren’t a product of what’s happening within your business; they can also be influenced by a host of external factors. Understanding these dynamics is essential because it can help you better prepare and even leverage them to your advantage. For instance, market conditions can have an outsized impact on your cash flow. Economic downturns or industry-specific slowdowns lead to reduced consumer spending, affecting your sales and thereby your cash inflow. In contrast, favorable economic conditions can result in increased sales, but they can also come with inflated costs for raw materials or labor.
Another critical external factor is the regulatory environment. Changes in tax laws or new industry regulations can add unanticipated costs that have to be met promptly, affecting your cash flow. Compliance really isn’t optional, and failing to meet new standards can result in penalties or disruptions that could cripple your business. Staying abreast of legislative changes in your industry is, therefore, essential. Just as internal auditing can help you pinpoint inefficiencies in your operations, keeping track of regulatory shifts can prepare you for changes that could impact your financial health.
Lastly, never underestimate the power of consumer behavior and the competitive landscape. Changes in consumer preferences can happen swiftly, and if you’re not agile enough to pivot, you may find yourself stuck with a huge amount of unsellable inventory. Similarly, new competitors entering the market can disrupt pricing strategies and customer loyalty, affecting your revenue and cash flow. The key is to be adaptable and responsive. Make use of market research and customer feedback to stay ahead of trends rather than just responding to them.
Tips for Improving Small Business Cash Flow
You may think having a cushion of cash on hand is a given, but you’d be surprised how many businesses overlook this crucial buffer. So let’s get one thing straight: No matter how buoyant your positive cash flow appears today, emergencies are never on the calendar. Create a cash reserve and safeguard it like you would your business reputation.
But treasury management also involves a nuanced understanding of your cash inflow and outflow. These two entities must shake hands in a timely fashion for your business to run smoothly. Let’s get into the specifics.
1. Keep cash on hand
Having cash reserves provides strategic flexibility. Unexpected opportunities, such as a prime investment or favorable bulk purchasing conditions, could present themselves. A strong cash position empowers you to seize these without hassle. Plus, a healthy cash flow improves your credit score, making future financing activities more accessible.
2. Manage your accounts receivable
You’ve provided a service or product, and now it’s time to get paid. But your customer’s timeline for settling invoices might not align with your accounts payable schedule. Solution? Speed up your accounts receivable. Implement a policy to collect receivables before payables are due. Consider using accounting software that allows you to track and automate this process. By doing so, you mitigate the risk of finding yourself in a cash flow crunch due to late payments or outstanding invoices.
3. Invoice promptly and accurately
How soon do you send out invoices after delivering a service? If the answer is anything other than “immediately,” you’re unwittingly contributing to potential cash flow issues. The earlier you invoice, the sooner you can bring cash into the business. Furthermore, make sure that your invoices are crystal clear and accurate. Any ambiguities could lead to delays in payment, affecting your cash flow negatively.
4. Smart inventory management
Holding too much stock can tie up cash that could otherwise be used more effectively. Conversely, running out of stock risks losing sales and, by extension, cash inflow. Therefore, an efficient inventory management process is non-negotiable. Using technology, such as inventory management software, can help you get real-time insights into your stock levels. This ensures you can fulfill orders while keeping inventory costs low, thus optimizing your cash flow.
5. Negotiate with suppliers
Your relationships with suppliers are a two-way street. You need them as much as they need you. Use this mutual dependency to negotiate favorable payment terms. Perhaps you could arrange for a more extended payment period during your business’s lean seasons or negotiate for discounts for prompt payments. Either way, the goal is to align your accounts payable with your cash inflow, contributing to effective cash flow management.
6. Leverage financing options
Sometimes external funding is necessary to bolster your working capital and improve cash flow. Various financing options can help, such as invoice financing. Another option could be securing a business line of credit, offering you the flexibility to borrow funds up to a certain limit, as and when needed.
7. Adopt cash flow forecasting software
If you’re serious about cash flow management, cash flow forecasting software is a tool you shouldn’t overlook. These platforms offer you insights through cash flow projections, helping you anticipate the future needs of your business. Predictive analytics can reveal trends and offer actionable recommendations, taking the guesswork out of financial decision-making.
8. Regularly review your financial statements
A firm grasp of your income statement, cash flow statement and balance sheet offers you a 360-degree view of your financial health. Regularly reviewing these financial statements can highlight trends, show the effectiveness of recent changes and point out areas for improvement. This is essential for making informed decisions that positively impact your cash flow.
9. Diversify revenue streams
Don’t put all your financial eggs in one basket. Diversifying revenue streams safeguards against significant hits to your income. This can be especially useful if your business is seasonal. Passive income streams, such as franchising, licensing or online courses related to your business can supplement your regular income, offering more consistent cash inflow.
10. Optimize pricing strategy
It may seem counterintuitive, but sometimes increasing prices can improve your cash flow. Conduct market research and competitor analysis to gauge your pricing strategy’s effectiveness. If you find that you’re undervaluing your goods or services, a price increase may be justifiable and could significantly boost your revenue. Be transparent with your customers about the change, and emphasize any added value or improvements to justify the new pricing.
How Bank Midwest Can Assist Your Small Business Cash Flow Management
We get it — you’re juggling countless responsibilities every day. That’s why we’re here to offload some of that weight from your shoulders, particularly when it comes to handling your finances. You see, at Bank Midwest, we’ve mastered the science and art of cash flow management, and we’re eager to apply this expertise to your unique business needs.
Let us help you with your cash flow management so you can focus on other crucial aspects of your business without financial stress. Interested in creating a more financially secure and prosperous future? Reach out to one of our Bank Midwest employees and let’s chart the course together.
Post updated. Originally published April 2020.
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