Last Updated on September 25, 2023
Proper cash flow management is the key to success for many small business owners. Unfortunately, small businesses that do not practice effective cash flow management strategies tend to fail quickly.
It’s not uncommon for young businesses to suffer from cash flow problems; in fact, it’s the norm. However, business owners need to focus on minimizing these problems wherever possible, which is why it’s paramount to learn about cash flow management strategies to implement within your small business.
What Is Cash Flow Management?
Cash flow management is the process of tracking money that comes in and out of a business, including where, when, and how much money is moving in and moving out.
Effective cash flow management allows small business owners to obtain a clearer picture of their organization’s finances. It’s a metric that assists businesses by demonstrating alterations or improvements that need to be made to certain internal processes that could impact cash flow.
Why Is Cash Flow Management Important?
Cash flow management is important for small businesses because it provides insights into a company’s performance and financial health, along with preventing small business owners from overspending.
Managing your cash flow allows you to make better-informed spending decisions. For example, if your business is in a period of negative cash flow, that signals it might not be the best time to hire additional employees or to buy that expensive piece of equipment you’ve been seeking. Instead, you’d want to shift your focus toward increasing funds coming into your business and making that your top short-term priority.
Understanding Cash Flow And How To Analyze Cash Flow
Before diving into cash flow management strategies, first make sure you know the meaning of cash flow in business, which is the measure of how much money is coming in and moving out of a business.
You should also understand the financial metrics and ratios that will help you analyze your business’s financial health. By doing so, you may be able to quickly identify how to improve your cash flow.
Important cash flow ratios include:
The term for analyzing these cash flow measures is called, “ratio analysis.”
Ratio analysis helps businesses understand whether they are liquid or if they will struggle to meet their short-term debts. A business with liquidity can pay its debts that are due within one year or less, while a business without liquidity does not have enough cash flow to cover them, an important discovery from cash flow analysis.
Remember that the aim for all small business owners should be to obtain a positive cash flow. This means that more cash is coming in than going out.
While many, if not most, small businesses will inevitably deal with negative cash flow, it’s crucial to avoid its long-term effects. Staying in the negative for too long can have serious consequences. You don’t want to dig yourself a hole that’s too deep to climb out.
Small Business Cash Flow Management Strategies
Once you understand how to analyze your cash flow, you can move on to implementing the following small business cash flow management strategies. As you review these, keep in mind that your inventory and accounts receivable are two of the biggest influencers of your cash flow. You bring cash into your business when you sell inventory and when your customers pay their accounts receivable credit. If you can collect on inventory and accounts receivable faster, then you can increase your cash flow.
Optimize Your Collections Process By Offering the Quickest Possible Payment Terms
When you submit an invoice to your customer, you’ve likely attached payment terms of anywhere from 15-90 days, unless that invoice is due on receipt. With longer payment terms, it becomes more and more difficult to stay on top of collections.
At some point, every company will experience issues with getting a customer to pay on time. This puts an immense amount of stress on you and the business as working capital gradually dries up.
If you and a client are working on Net 60 payment terms, discuss the possibility of switching to Net 30 upon the end of the existing contract. If you’re working on Net 30 payment terms, discuss moving to Net 15.
If an existing client is hesitant to change payment terms, or a prospective client wants payment terms that are longer than you’d like to provide, consider offering payment discounts.
An example of a payment discount would be 1/10 Net 15. This means that if the customer pays within the first 10 days of receiving the invoice, they get a 1% discount. If they don’t pay within the first 10 days, then the payment is due within 15 days. A more common discount is 2/10 Net 30, but if you’re looking to accelerate payment, you may want quicker customer payment terms than Net 30. Shortening payment terms will accelerate the cash conversion cycle.
Get The Most Out Of Your Accounts Payable
You can also improve your cash flow by planning the payments you make in advance. To make your cash last longer, pay your accounts payable on their due dates. If you pay them before the set due date, you are not maximizing your cash flow. The idea is that you get to keep your cash on-hand longer, and you can use it to manage business operations, rather than sending it to another company.
Remember that while you want to extend your payment cycles as much as possible, you still need to pay on time. If you make late payments, there’s a good chance that additional fees will be added, costing you more. The goal with this cash flow management tip is to pay your bills as slowly as possible (within reason), keeping more cash available for your business.
Create a Cash Flow Forecast
Every small business owner should expect to deal with cash flow problems. However, it’s the decisions you make once you’re in that period of negative cash flow that can make or break your business.
Let’s say you run a small staffing agency. You’ve analyzed your cash flow, and the results show you have enough cash on-hand to further invest in your business. Two potential expenses that could help your agency include purchasing a new customer relationship management software and hiring a marketing director to lead your staffing agency’s marketing efforts.
This is where creating a cash flow forecast would come in handy. By predicting future cash flows, you’ll be able to better analyze if you can afford both of these potential costs, just one, or neither.
Invest In Cash Flow Management Software
Cash flow management software automates the process of managing your current and future cash flow. It can save small business owners who are juggling multiple projects a lot of time.
For instance, once you’ve created an income statement and balance sheet, a cash flow management software can automatically take these statements from your accounting system and turn them into cash flow statements and future cash flow forecasts, accelerating the small business cash flow management process.
Let’s be honest – invoicing clients isn’t one of the most thrilling aspects of running a small business. However, the best small business owners are able to get one step ahead of others by accelerating cash flow by being creative with their accounts receivable.
For example, e-invoicing, the process of sending invoices electronically, is significantly quicker than sending invoices by mail. E-invoicing leads to customers receiving invoices faster and ultimately your business getting paid more quickly. It also reduces manual labor on your end and lessens the chances of human accounting errors, which could save time and money in the long-run.
Consider Invoice Factoring
Invoice factoring is a popular alternative financing method for small business owners who are looking to boost cash flow and improve working capital. Regardless of whether you’re dealing with slow-paying customers or not, invoice factoring can prove beneficial, as it takes a significant amount of the stressors pertaining to accounts receivable off your shoulders.
The invoice factoring process can be broken down into five steps:
1. Your business provides a service to a customer, then sends an invoice to that customer (Day 1).
2. Your business submits that same invoice to a third-party invoice factoring company, such as altLINE (Day 1).
3. The factoring company sends your business a cash advance, typically 80-90% of the invoice value (Day 2).
4. Your customer mails their payment to the factoring company, which goes into a lockbox in your business’s name (for example, Day 25).
5. Payment is complete. Your business then unlocks the remaining 10-20% of the invoice value, minus a small factoring fee (for example, Day 26).
As you can see, the cash advance provided by the factoring company allowed you to have working capital for over three full weeks that you wouldn’t have had otherwise.
Small Business Cash Flow Management FAQs
How should you deal with cash flow problems in a small business?
Cash flow problems can be frustrating to deal with as a small business owner, but there are many potential solutions to increase cash flow and help your business run more smoothly. For example, you could pay your outstanding invoices more slowly while sending invoices to your clients more quickly, keeping cash in your business for longer and encouraging customers to pay in a timelier manner.
Additionally, if you operate a business that requires heavy machinery, you could look into leasing the equipment rather than purchasing it outright to maintain healthier cash flow in the short-term. You should always keep your eyes peeled for ways to how to improve your cash flow.
Why is cash flow important to a small business?
Maintaining a healthy cash flow is important for small businesses for many reasons. Cash flow is the movement of money in and out of a business, and business owners should aim to have a positive cash flow, meaning you have more cash coming in than going out. While cash flow can impact important financial metrics such as profit, it also affects your ability to maintain and grow business operations. To run a successful business, it’s imperative that you keep an eye on your cash flow and manage it appropriately so that you do not find yourself in financial turmoil that irreversibly damages your company.
Jim is the General Manager of altLINE by The Southern Bank. altLINE partners with lenders nationwide to provide invoice factoring and accounts receivable financing to their small and medium-sized business customers. altLINE is a direct bank lender and a division of The Southern Bank Company, a community bank originally founded in 1936.