Your company receives an invoice offering an early payment discount if you pay the bill within ten days. The company that invoiced your business used a common technique to get paid as quickly as possible, probably to optimize cash flow.
For a business to survive and thrive, don’t underestimate the power of cash flow. Cash flow is the movement of funds into and out of an organization over a period of time. It can make or break a small business.
Finance Terms Defined
Some of the terms discussed in this blog are defined below:
- Positive cash flow: the goal of most small businesses and an indication the business is healthy. Having a positive cash flow means having more money coming into the account than going out.
- Negative cash flow: just the opposite — less money is flowing in than flowing out.
- Cash flow statement: provides a snapshot of a business’ cash at any point in time.
- Cash flow forecast: a financial report used to plan ahead. It projects cash movement for a future period, such as a quarter or year, based on a business's backward-looking cash flow patterns.
- Working capital: the cash on hand or other financial resources that can be converted quickly to cash needed to maintain a business’ daily operations.
- Line of credit: unsecured funds from a lender that your business can draw on as needed. It serves as a short-term funding option and provides quick access to cash.
Small businesses have specific considerations when it comes to cash flow
People often consider financial advice geared toward larger businesses or companies to be generic enough to apply to small businesses. However, that most often isn’t the case.
Businesses with fewer assets, sales volume, or employees don't always have the resources to weather financial hiccups as large companies do.
An article published 40 years ago in the Harvard Business Review holds true. It provides an in-depth look at how a small business is not simply a ‘little big business’ and discusses the financial management tools small businesses can utilize to maximize their resources. Even though modern business has changed significantly in the past few decades, the first management tool they discuss is the importance of predicting cash flow.
The HBR article points out that for large companies, “the principle that cash flow equals net profit plus depreciation and amortization is correct for a system in perfect equilibrium. Small differences from equilibrium do not significantly distort the underlying principle.” It is much easier for larger companies to borrow funds or draw on other resources as needed to maintain their equilibrium. The article notes that small businesses are seldom in balance and have a much more difficult time maintaining or borrowing the funds needed to ride out market fluctuations or other impacts.
Keeping this in mind, let's consider ways to improve small businesses' cash flow and move toward equilibrium.
Tactics to improve your cash flow
Effective cash flow management helps your business meet its financial obligations. It also provides the flexibility to launch new projects, products or services.
Begin with the appropriate data
Monitor the cash flow statements regularly. They contain critical numbers that show whether you are spending more than you’re making. Remember, being profitable does not mean the business will survive because you can’t pay bills with profits.
The cash flow forecast is essential for planning future business decisions. The patterns found in your previous cash flow will shape upcoming expenditures.
Target unnecessary costs such as services not being used or subscriptions first. Then look at regular expenses and see if there are ways to scale back. Can you refinance loans or renegotiate leases? Can you make payments on purchases as opposed to lump-sum payments? What about payroll, are all positions mission critical?
Analyze payment methods
Getting paid as quickly as possible is important to improving your cash flow. Invoice as soon as the work is complete or the product is delivered. Send simple easy-to-read invoices encouraging prompt payment. There are several invoicing tools available online or with accounting software that can be utilized. Email invoices to the appropriate person or department so they don’t get lost in the shuffle.
Using payment apps or direct deposit can expedite payment. If that is not an option, cash and card payments are preferred, carry the least risk and are quickest. Checks are a bit slower and have the chance of being returned. There is also the credit option. Providing a credit option will slow your business cash flow and carries non-payment risk. If you provide a credit option, take steps to protect your business by ensuring customers are qualified. Check credit reports and references, perform background checks and ask for a deposit on transactions.
Have cash reserves
Maintaining a financial cushion is one of the best ways to practice effective cash flow management. It’s a good idea to have 3 to 6 months of savings readily available to cover business expenses. If you don’t have any reserves, start working toward building savings now. Including savings as a budget item is one way to start.
Until your company has an appropriate reserve, you could utilize a business line of credit to manage cash flow in the event of an unexpected problem or challenge. Don’t use loans or credit for regular operating costs such as payroll or rent. When applying for credit, make sure to pay attention to terms, conditions and APR.
Growth costs cash, so plan accordingly
While the ultimate business goal is growth, it takes financing. The need for additional space, equipment, staff and material will all impact cash flow. Having cash reserves or a line of credit can help the endeavor, but move cautiously and make sure you have the working capital to support the expansion.
Remember that cash is king
Cash reserves are a valuable benchmark of small business financial health. According to the JPMorgan Chase Institute, the median small business is essentially living month to month with enough cash to withstand 27 days without cash inflows to their business.
Utilize an outsourced CFO
Small business owners can work with an outsourced CFO to achieve effective cash flow management or make other strategic financial improvements to their business. They will bring the expertise and experience needed to develop cash flow reports, projections and recommendations.
Ascension has the solution
But if all this talk of business finances seems overwhelming and you prefer to focus on business operations, let us handle the details.