5 Common Cash Flow Management Mistakes
Cash is the lifeblood of every small business, and good cash flow management is essential to success. Without it your business could hit a rough patch and fail to recover.
Cash flow management is the process of managing the cash that comes in through sales and the cash that leaves through expenses. Good cash flow management ensure there is always enough cash available for you to conduct business and weather the unexpected.
“Having cash on hand in a business is critical to support expenses, inventory, payroll and to pay yourself, too,” said Jennifer Myers, certified financial planner and president of SageVest Wealth Management. “Revenues and expenses seldom track equally throughout the year, but you still have to pay the bills.”
Ruth King, small business consultant and author of “The Courage to Be Profitable,” agreed. She said it all comes back to good cash flow management and business basics. “The only way you can pay your bills is with cash,” King said.
Myers and King shared five common cash flow management mistakes small business owners should avoid.
Not having enough cash on hand at all times
Every small business needs reserves — liquid cash you can access immediately if necessary. Too many small businesses fail because they don’t have enough cash available when they need it.
Myers stressed the importance of having cash reserves to survive times when your business model may not be working well or during economic downturns.
King advises her clients to save a percentage of every dollar they make.
“Put at least 1 percent of every dollar that comes in the door in a savings account. This is an easy way to save.”
Confusing profits with cash flow
A fatal mistake many small businesses make, according to King, is not understanding that the bottom line of your profit and loss statement is not the cash you have in the bank. “It is the profit you earned for a specific period of time. You can have a profit and have no cash in the bank and have a loss and a lot of cash in the bank,” she said.
Myers said discrepancies can occur for many reasons. “Profits can exceed cash flow in years when you have large cash outlays, and conversely, that cash flow can be more plentiful than profits in later years due to continuing depreciation tax benefits, for example.”
Being debt free but cash poor
Many small business owners avoid debt at all costs; however, sometimes it’s better to carry a little debt than to completely deplete your cash reserves.
Under certain circumstances, debt can serve an important purpose, said Myers. “Rapidly growing companies often require debt financing to fund expansion efforts. Borrowing to meet growing demand can be a wise decision if you’re confident that revenues will continue growing and support debt payments,” she said.
King agreed. “For example, you need a new truck and take out a loan to pay for that truck. If you are a plumber or HVAC or any other company that has trucks on the road, that truck is earning you much more than the monthly payments on it. In these cases, it makes sense to purchase a vehicle using a loan.”
Having the wrong pricing strategy
Profits generate the cash you need to keep your small business going, and the key to generating maximum revenues is a winning pricing strategy. You may want to consider consulting a professional to help you set the best prices for your goods or services.
King suggested deciding what net profits you want, then working backwards. Tracking gross margins is a good way to verify you’ve set your prices well. “Good consistent gross margins generally mean proper pricing,” said King.
She also advised against thinking you can take a loss on some items and make it up on others. “Small businesses are not supermarkets. We can’t afford loss leaders,” she said. “Remember, collecting profitable sales leads to positive cash flow which leads to the cash you need to pay your bills.”
Not having a realistic budget
One major reason many small business owners lack optimal cash flow is they fail to create a budget that plans for the unexpected — both good and bad.
“If the business accelerates, you need to think ahead about cash needs for expansion. Conversely, if things become tight, you need a plan to manage cash flow while you get the business back on track,” Myers said.
“Today’s environment is changing more quickly than ever and businesses must stay ahead of the curve to succeed long term. Sustaining and growing a business requires investing in technology and other resources to maintain a competitive edge. Make sure you budget both time and cash to staying current and viable,” Myers said.
Another key budgeting factor, said King, is keeping a close eye on your cash flow. “Watch your cash, at a minimum, every week,” she said. “Using a weekly cash flow report can take care of this.”