How to improve your cash flow management
It's a common misconception that a small business can survive on sales alone. Most business owners either know ahead of time or quickly learn that sales alone don't equate to a heaping amount of cash. You need positive cash flow — and to accomplish this, you need cash flow management.
To help you stay on top of your financial health and ensure your business has enough cash to thrive, let's take a look at what cash flow management is, why it's important, and how you can become a guru of effective cash flow management.
What is cash flow management?
Before diving into cash flow management, it's essential to understand what cash flow is in the first place. Cash flow is any money coming in or out of your business. Positive cash flow means you have more money coming in than going out. In contrast, a negative cash flow means there's more money going out than coming in.
Positive cash flow is a sign that your business is doing a good job balancing income and debt, while a negative cash flow can mean one of two things: your business is growing and you simply have a lot of growth-related expenses, or your business is struggling to drive a profit and you're in trouble.
Cash flow management is the practice of understanding and shaping your cash flow. This skill is a must for small business owners, as it allows you to make educated business decisions, like knowing the impact a new invoicing policy can have on your cash flow. Poor cash flow management leads to uneducated decisions and is a common reason why businesses fail.
There are times when cash flow is somewhat out of your control, like during a market downturn (or a global pandemic.) But proper cash flow management is always a skill worth having, as it can help your business even during the darkest of times. Fortunately, there are practices and policies you can implement right now that will help you down the line.
6 effective cash flow management tips
Effective cash flow management is all about maximizing your working capital so you can invest more in your company. The following tips will help you manage your cash flow like a pro and build healthy cash reserves.
1. Understand your cash flow statement
Before you can manage your cash flow, you must understand your cash flow on a surface level. A cash flow statement is exactly that: a surface-level recap of your cash flow.
A cash flow statement gives you a quick overview of your bottom line, with the following information:
- Operating activities cash flow: Like operating expenses, operating activities are actions that directly tie to your company's income. This can include asset- and liability-related cash flow.
- Investing activities cash flow: Any cash inflows or cash outflows from investing should appear on your cash flow statement sheet. Equipment expenses, building costs, or software purchases are common investing activities.
- Financing activities cash flow: If you sell stock, issue stock, sell equity, or partake in any other business activity that involves outside investors, it's a financing activity.
Much like looking at a balance sheet for the first time, a cash flow statement may seem intimidating. But this information will become second nature in no time.
2. Regularly run cash flow projections
A cash flow projection provides an estimate of your potential cash flow in the future. A cash flow projection can help you get a hold on business expenses before they become a problem. It can also help you see where your business needs could be in months or years. A cash flow projection ultimately increases your chances of having a healthy cash balance by offering knowledge and foresight.
To run a cash flow projection, you need to pick a time period, like a quarter or year. You'll then take your sales from that period, total up the cash and subtract expenses, and have your estimate for what your cash flow might be for that same period in the future. Be mindful of holidays or other events that might impact sales and cash flow.
3. Stay on top of invoicing
Accounts receivable plays a huge role in cash flow management. If you have customers failing to pay on time, you're missing out on free cash flow.
Implement strict payment terms to ensure your customers pay on time. And follow up promptly. For example, if your payment terms state payment is due within 30 days of purchase, call or email your customer in a week or two to remind them that payment is due within 30 days.
If you're not using online invoicing already, consider setting it up now. Online invoicing allows you to quickly send invoices, accept more payment options, and generate automatic income statements, depending on the software.
4. Don't offer everyone a line of credit
Every financial institution doesn't readily hand out credit cards. Your business should be no different. A line of credit is an excellent way to give a new customer more spending power and even build brand loyalty. But it's also a quick route to a deep hole if you're not careful.
Much like late invoices, a bad line of credit can hold up your business's cash flow and yield nothing in return. As part of your previously-mentioned payment terms, state clear and strict credit requirements. Consider using a third-party creditor to do a lot of this heavy lifting for you.
If you're worried about losing potential customers by not having lenient lines of credit, set up a loyalty or rewards program. This can cost you next to nothing, and will still have the same effect as a line of credit: driving customer loyalty.
5. Implement accounting software
Accounting software, like Quickbooks, automates and streamlines a lot of your finances. This software can sometimes generate cash flow projections, saving you lots of time. Accounting software can often sync with any business credit card, making it easier to track business expenses.
If you can sync your point of sale system with your accounting software, you can see your net income, quickly create invoices, and generally take a lot of the grunt work out of accounting. This will ensure your numbers are accurate, making any projections and cash flow management more effective.
6. Reduce spending
It might sound like a no-brainer, but reducing spending is always worth pursuing. Audit your utilities, rent, software, and even employees or freelancers to identify areas where you can reduce spending. You might be surprised to find you're paying for software your team no longer needs.
Check any upcoming capital expenditures, like a major building or equipment purchase, to see if they're really necessary. If you're currently in a cash flow slump, try holding off on any large expenses for the time being.
Cash flow problems, be gone
Cash flow problems can hurt your profit margins, sabotage any business plans you have, and result in numerous shortfalls that add up to one big fall. With the above tips, you can start managing your cash flow in no time and have a better view of your business as a whole.
You can't control everything. But you can control many decisions within your business, as well as how much you understand about your company. In the case of cash flow management, knowledge is power. And with that power, cash flow problems don't stand a chance.