Small Business Guide to Cash Flow Management

Step-by-step advice to help you understand and optimize your cash flow to protect and grow your business.
cash flow graph
Managing your cash flow means making sure you always have enough cash on hand to make payroll, pay suppliers, vendors, and other expenses. (Photo: pupunkkop/Shutterstock)

More than any other single factor, cash flow determines the success or failure of your business. Unfortunately, many small business owners struggle with managing their cash flow, or they don’t manage — or even understand — it at all.

Tage Tracey

“Business owners are generally fixated on the income statement — what sales were generated, how much did we make or lose, etc. — and haven’t a clue when it comes to understanding cash flow.” -Tage Tracey (Photo: Tage Tracy)

Why is cash flow management so critical? The bottom line: Even if sales are strong and profits healthy, if you have negative cash flow, you could still run out of money to pay bills. And that could spell trouble (sending you scrambling to find additional funding) or disaster (if you can’t find it fast).

“Business owners are generally fixated on the income statement — what sales were generated, how much did we make or lose, etc. — and haven’t a clue when it comes to not just understanding cash flow but more importantly, how to proactively manage the business to improve cash flow and build liquidity,” said Tage C. Tracy, on-time CFO and co-author of several books including “Cash Flow for Dummies.”

Tracy called cash flow “the most important financial statement/concept for a small business owner to truly understand, and the least understood.”

Cash flow management is not rocket science. Every small business owner can learn it. This guide covers the essentials, including how to improve your cash flow to protect and grow your business.

What is cash flow?

“Cash flow is money coming in and going out of your business. It’s really that simple,” said Denise O’Berry, a consultant who helps small businesses improve their cash flow. O’Berry is author of “Small Business Cash Flow: Strategies for Making Your Business a Financial Success.”

“Small businesses think about cash flow as a math activity, and that’s why so many shy away, when in fact small business cash flow isn’t really about math at all. It’s about the story of your business — the successes, the not so great things that happen, the failures. It’s something that every single small business owner needs to pay closer attention to.”

Managing your cash flow means making sure you always have enough cash on hand to make payroll and pay suppliers, vendors, rent and other expenses, plus cover any debt payments you owe, even during slow periods and times you need to make large cash outlays.

Cash on hand does not include money customers owe you. It’s not the same as the number at the bottom of your profit and loss statement, which is why you need a separate cash flow statement.

“Just because you have a profit on something doesn’t mean that you have a balance in your bank account,” said O’Berry. “A business works on sales and expenses. I could make $1,000 profit on the sale of something, but if my expenses — meaning debt, employees, inventory — if all of that stuff adds up to more than what that profit is, guess what: I have a negative cash flow.”

Tracy calls this concept being “in the black but where’s the green?”

Unfortunately, it’s often par for the course. “One of the big problems with many businesses,” said O’Berry, “is that they have a time lag on doing work and then getting paid, which causes some real issues.” Good cash flow management can get you through those lags and also shorten them.

Tracy said most small business owners obsess over their P&L. “They don’t understand the amount of capital and cash that’s required to really operate and grow a business, so they end up in a lot of stressful situations.”

A cash flow statement — and especially a cash flow forecast — are the tools you need to gain these insights.

Tracking and forecasting cash flow

The cash flow statement reports on the sources and uses of cash over a period of time (whereas the balance sheet is a reflection of assets, liabilities and net equity at a specific point in time), said Tracy. Cash flow statement templates are available online, or use a basic spreadsheet. Your online accounting software can probably generate a cash flow statement, too.

Denise Oberry

Cash flow consultant Denise O’Berry recommends using a six-month cash flow forecast to predict sales and expenses. (Photo: Denise O’Berry)

A cash flow forecast, aka projection or budget, is even more important. It predicts sales and expenses over a future period — how much cash will come in, and how much you will need to lay out. O’Berry recommended looking six months ahead; Tracy said one year is his minimum, so you can truly understand your peaks and valleys. Here’s one example of a 12-month cash flow template. And here is O’Berry’s worksheet.

Use past accounting reports and knowledge of your business to inform your cash flow forecast.

Looking ahead lets you anticipate problems and act in time to avoid them. Do you see a month in which you’ll have to lay out more cash for inventory or equipment or debt payments than you’ll receive through customer payments?

Tiffany C. Wright, CEO of The Resourceful CEO and author of “The Funding Is Out There! Access the Cash You Need to Impact Your Business,” said, “Any negative cash flow weeks you observe need to be immediately converted to zero or positive through a line of credit, equity injections, customer deposits, better collection efforts, better credit policies, etc.”

By managing your cash flow you’ll not only avoid the toxic situation of paying people and businesses late, you’ll have cash to invest in the business (purchasing new equipment, increasing inventory, funding a marketing campaign or event) when you want to.

Nick Braun, CEO of the online pet insurance agency, said, “We manage burn rate internally using Excel. We have a rolling annual budget broken down by month that gets updated each month based on the previous month’s results.” Each month’s budget starts and ends with cash.

“It’s a simple method that factors in P&L and balance sheet changes. This method allows me and our Board make strategic decisions without running out of cash. And if we decide to accelerate growth or there are changes in performance, we have a 12-month runway at all times.” That long runway, said Braun, “gives us plenty of time to raise money or find debt financing” if cash is needed down the road.

How to improve your cash flow

Improving cash flow means selling more and spending less. No surprise there. But it also means delaying cash outlays for as long as possible, getting paid as fast as you can and turning over inventory lickety-split.

Here are some of the key principles of good cash flow management.

Build a cash cushion. When business is good, put away money every month to get you through lean periods. O’Berry recommends having three months of typical expenses in reserve.Ruth King, small business consultant and author of “The Courage to Be Profitable,” advised putting at least 1 percent of every dollar that comes in the door into a savings account.

Anticipate cash crunches. Use your six- or 12-month cash flow forecast to recognize when cash will be tight. Then figure out how to boost sales or cut expenses.

Understand your selling cycle. Most small business owners underestimate how long it takes to build, market and sell a product and then collect on sales, said Tracy. “If you think it’s six months and it turns out to be a year, you don’t realize how much cash or capital you need to entirely support your selling cycle. One of the most common reasons businesses fail is the lack of proper capital. There’s nothing worse than having to go back to people and say, ‘I blew it and I need more money.’”

Negotiate faster payments. O’Berry said, “One big mistake so many service providers make is they negotiate contracts so their invoices have a net 30 day payment cycle.” If you do the work on the first of the month, then issue the invoice on the last day of the month and don’t get paid for another month, “you’re being a bank to you customers. You should never be a bank to your customers.” Ask for a shorter cycle. If you’re providing a service to a company, make sure you know who pays the bills in the company, and deal with them one-on-one. “That person needs to be your friend,” said O’Berry.

Encourage customers to pay on time. Send out automated reminder emails, and send a personal email or pick up the phone if those don’t work. Consider offering a small discount for cash on delivery or net 10 day payment, the Small Business Administration recommends.

Require interim payments on large orders or projects. Establish a retainer plan. If it’s a big project, break payments down by deliverable points. Ask for a down payment to cover initial costs.

Pay suppliers later. Don’t pay until the last day you can. If payment is due in 30 days, pay on day 30. Also, “proactively manage vendors and suppliers and set their expectations,” said Tracy. “Your vendors or suppliers want to work with you. You’re their customer. It’s very helpful to establish credit terms that are more attractive during tight periods and repay them when the cash is available.” If your business is seasonal, you might ask for a 30-day term during most months but a 90-day term when you need more time to pay.

Manage inventory proactively. “Everybody always wants to believe that every piece of inventory they have is going to sell. That’s not the case,” said Tracy. Do what’s necessary to make sure inventory turns over quickly, and don’t get emotionally attached to inventory that’s not selling. Tracy cited an example of a watch company with leather bands that were unpopular. By comparing inventory to average monthly sales, they realized they had 23 years of inventory on hand. They launched an aggressive sales campaign to turn that inventory into cash. You can also sell to a third-party liquidator if need be.

Cut expenses. There are many ways to do this, from renegotiating debts and credit line interest rates to putting off new equipment purchases and paying vendors in cash if they offer a discount for it (and if you have the cash available).

Get rid of obsolete equipment. Selling it if it’s still worth something is one way to get an infusion of cash.

Sell more product. Initiate a new marketing campaign on social media, through email or otherwise to attract new customers. Partnering with other local business owners can also help you move more product. Consider opening a pop-up store and marketing it to create buzz. Or have a sale, suggested O’Berry. “You could put together a special that packages two different products together that’s a really good deal for your customers.”

Raise prices. But, advised Lou Davenport, a mentor at SCORE, a non-profit association dedicated to helping small businesses through education and mentorship, “Remember that prices are market-driven, not cost-driven. It doesn’t matter what your costs are because the market doesn’t care. What matters is if you can make a profit at price the market will bear.”

Lease instead of buy equipment. This may or may not pay off in the long run , so do your research.

Use debt correctly. A common mistake Tracy sees is that small business owners mismatch their capital structure. “They will use long-term debt to finance short-term assets, or even worse, use short-term debt to finance long-term assets. Make sure your balance sheet is probably balanced long and short term.” Need to finance a manufacturing facility? Do it with a loan or through investors. Need to pay for inventory? That’s best financed with short-term debt like a short-term line of credit.

Secure additional financing. If you run into serious trouble and need cash fast, you have options. If you can’t get a bank loan, options range from accounts receivable financing to factoring.

Keep your eyes on the road ahead

Update and analyze all of your accounting reports — your income statement, your balance sheet and your cash flow projection — on a regular basis. Weekly is best, said O’Berry.”Business aren’t static entities. There’s stuff happening all the time.”

“Way too many small business owners look at their reports once a year when they do their taxes. Other than that they might just look at the balance in their checking account, which is a horrid way to manage your cash flow.”

O’Berry compared running a business to driving down the road: You need to look at the windshield more often than the rearview mirror.

Reading the road takes just 15 to 30 minutes each week, she noted. “And it’s the survival of your business you’re talking about.”

Finally, don’t hope for success; plan for it. “Hope is not a strategy,” said O’Berry, “so don’t just hope your business is going to get better. Really look hard at your situation, and most people can dig themselves out of a hole if they get in it.”

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