published Dec 05, 2023
Cash flow is one of the top five challenges small and medium-sized businesses face, and this problem is an offshoot of multiple wrong decisions. Such choices include bad debt, a lack of business budgeting, unplanned expansions, and insufficient cash reserves. You may be surprised to know that 90% of all failed businesses had poor cash flow management.
This leads us to the question: Do you keep track of your incoming and outgoing payments? If you don't, it is important to master the art of cash flow management. This article highlights small business cash flow management issues and cash flow management best practices. Read on!
Understanding Cash Flow Basics
Cash flow is the cumulative amount of money transferred into (inflow) and out of (outflow) an establishment's account. When customers purchase a product or service, money flows into your business account. However, there are expenditures that these inflows cover daily.
To run a successful business, you must ensure you have positive cash flow. A positive cash flow means that the cash generated or liquid assets owned by the company are higher than the cash spent on running the business. On the other hand, negative cash flow means that more money is flowing out than in.
This can equate to a mismatch in expenditures or losses, but whichever one it is, negative cash flow does not fuel long-term growth. There are three common types of cash flow:
Operating Cash Flow: This entails the money spent on covering daily and monthly expenditures that keep the company up and running. Such expenses include salaries, utility bills, transportation, taxes, rent, etc.
Investing Cash Flow: This is the money spent on long-term investment opportunities. Investing cash flow can result in a negative cash flow for your company at that point, but if your ROI increases or you sell off the assets, shares, or bonds, it will lead to a positive inflow.
Financing Cash Flow: Financing activities cover actions between a business and its lenders, whether they're receiving investments or paying off dividends, shares, debts, and equity. Basically, it is how an enterprise raises capital and takes care of its investors.
As long as the liquid assets or cash generated from these activities are greater than the resources spent, your company will continue to have a positive cash flow. However, if the reverse is the case, you must consider managing cash flow effectively, or you'll ruin your chances of staying in business long-term.
Identifying Cash Flow Bottlenecks
Running a business involves a constant exchange of assets and cash from one party to another. Some common ineffective cash flow management problems include:
Late Customer Payments: 93% of companies experience late customer payments for many reasons, and this affects cash flow management. If a majority of customers pay late, the business will have to go the extra mile to fund operational costs.
Low Sales and Profits: Sales and profits are one of the major inflow sources. But if your business has low sales and becomes unprofitable, potentially due to poor employee productivity or ineffective marketing, there will be barely any cash to cover operational costs.
High Overhead Expenses: Overhead expenses are expenditures that are not related to the production or selling of your products. They include taxes, rent, and other utility bills. If such bills are not managed effectively, they'll affect your cash flow.
Bad Debt and Late Debt Payments: Every business, no matter the size, can incur debts. Aside from debt incurred by the business, bad customer debt and late payments also put your business on the edge. Both can negatively impact your cash flow.
Not Creating a Budget: Budgeting is an important part of starting and running any business because it serves as a blueprint for cash flow management. Poor budget planning is one of the factors contributing to the failure of 45% of SMEs in the first five years.
Avoiding Emergency Funds and Insufficient Cash Reserves: Unexpected expenditures are unavoidable in a company. An emergency fund is three to six months’ worth of cash reserves that you set aside as a business to cover unexpected expenses. Insufficient cash reserves or lack of emergency funds can leave you vulnerable in the event of an emergency.
Expanding Too Fast: Expanding your business operations or setting up a new location can be a good thing and a sign of growth. However, without proper planning or strategies for managing cash flow at this point, you might lose more resources than you expect.
Too Much Investing Cash Flow: While investing in assets with short-term or long-term value can lead to positive cash flow in the future, it is not advisable to invest too much or in too many stocks, bonds, etc. These investments can go bad, leading to loss of resources, bad debt, and other cash flow problems.
Overstocking and Too Much Outsourcing: Overstocking raw materials for manufacturing can tie up funds and limit the spread of resources across other operations. Also, outsourcing ingredients or raw materials from other countries can lead to negative cash flow, considering shipping costs and other expenditures.
The above are some of the most common small business cash flow management issues, and they can all be resolved by understanding the ins and outs of effective cash flow management. The next section highlights some of the best practices you can follow.
How Can Businesses Effectively Manage Their Cash Flow?
Managing cash flow is the best way to avoid all the problems relating to negative cash flow. This is because this knowledge enables you to understand where you're spending too much and how to spread these resources across various company operations and cut down on unnecessary expenses. Here are some cash flow management best practices.
1. Manage Incoming and Outgoing Payment
Keeping track of incoming and outgoing payments is one of the best ways to know what is going on with your company's cash flow and how much you owe. You can also avoid paying suppliers more than once or asking customers to pay for their purchases twice.
It will also enable you to identify customers who make early payments and those who don't, cutting off the late payment cash flow management issue. Monitoring your incoming and outgoing payments may not be easy for some businesses, but here are some best practices for managing payments:
First, establish clear invoicing and payment policies and billing procedures.
Aside from cash and manual payment methods, use electronic billing and online payments. But if you use cash, ensure it is recorded in the company's system.
Use the right key performance indicators (KPIs).
Late customer payments and bad customer debts are top small business cash flow management bottlenecks. So, set credit and collection policies and stick to them.
Use various payment methods, including cash, checks, wire transfers, credit cards, cryptocurrencies, and debit cards.
Automate payments to save time and money.
Make payments easy for customers.
2. Identify and Fix Problems Quickly
Another best practice for managing cash flow effectively is to identify inflow and outflow problems, like ineffective marketing campaigns, poor branding, inadequate sales, low profits, unexpected expenses, expensive raw material outsourcing costs, etc. Once you identify your cash flow problems, ensure you fix them quickly to get your business back on track.
3. Set Up Efficient Billing Cycles
Billing cycles are the intervals between when a company sends out customer invoices and the expected payment date. This is important because it lets customers know how much they owe, plan and budget their expenses, and avoid late payments. On the other hand, it helps businesses avoid late customer payments.
There are various types of billing cycles; they include:
Monthly billing cycles are commonly used among businesses and cover one-time monthly payments.
Quarterly billing cycles cover payments for products and services every three months.
Annual billing cycles require that customers are billed once yearly.
Weekly billing cycles mean that customers are billed once a week.
Bi-weekly billing cycles are similar to weekly billing cycles, but customers are billed once every two weeks.
Whichever billing cycle you choose for managing cash flow, confirm that it is automated for speed and accuracy and that customer accounts are properly managed. Additionally, notify clients of their payments early and ensure the cycle is beneficial for your business's cash flow.
4. Analyze Cash Flow Patterns
Cash flow patterns are the way money flows in and out of your company consistently over a particular period. Analyzing this pattern will give you insights into your sales, profits, and operational expenditures. In addition, it will enable you to make more accurate forecasts for the next month or year.
For better small business cash flow management, here are some tips on monitoring, analyzing, and forecasting patterns:
Gather previous data and look for consistent patterns.
Identify all sources of inflow.
Identify all business outflows.
Create your cash flow statement.
Analyze your cash flow statement.
Identify a data point or an existing problem in your cash flow.
Choose a forecasting period.
Conduct market research or use any of these seven financial forecasting methods.
5. Reduce Debt
As of 2021, 17% of small and medium-sized businesses in the United States owe an average of $200,000 in outstanding debt. If you have existing debts that need to be cleared, here are some strategies for reducing debt levels and managing cash flow without affecting your operations:
Revamp your business budget to match your cash flow needs.
Improve your cash flow.
Review and prioritize your debts. Start by paying off high-interest debts down to lower-interest debts. However, if there is no big difference, pay off smaller debts first to avoid overwhelming your business.
Review loan terms and consider refinancing.
If you currently don't have debts or have successfully paid off outstanding loans, prevention is better. If you are stuck or are looking to expand, instead of taking out new loans, consider pitching to angel investors and business accelerators.
Get the Cash Flow Coaching You Need
With the cash flow management best practices highlighted in this article, you can effectively manage your inflows and outflows without disrupting your operations. However, these tips may not be effective if you don't have in-depth knowledge of maintaining a positive cash flow. To stay ahead, schedule a call with Foreword Companies. We offer straightforward and well-rounded business coaching for startups, entrepreneurs, and large companies.