NOTE: This article is intended to inform our readers about business-related concerns in the United States. It is in no way intended to provide financial advice or to endorse a specific course of action. For advice on your specific situation, consult your accountant or financial consultant.


“Cash is king” is a mantra that resonates with small business owners, who often struggle to find funding during the early stages of their business. However—despite the fact that a steady cash flow is one of the most critical aspects of small business success—82 percent of small businesses fail because of poor cash flow management strategy.

Key cash flow challenges that small business owners face result from:

  • Focusing on other aspects of the business, such as hiring, tax management, and customer relationship management.
  • Dramatic seasonal changes in sales, which make it difficult to assess the impact of sales numbers on cash flow in the long term.
  • Incorrectly assuming that a big sale or securing a long-term line of credit will maintain cash flow in the long term.
  • A lack of “triggers” in place to predict low cash flow, such as advanced analytics functionality found in accounting software.
  • Lack of financial training or knowledge to assess how cash flow is affected by accounts receivable (AR) and accounts payable (AP).

These are just some of the broader small business cash flow challenges, which, when combined, become the perfect recipe for small business bankruptcy and failure.

Small businesses that don’t explicitly incorporate a cash flow management strategy into their startup plan are likely to find themselves among the 82 percent of small business that fail within a year because of poor cash flow management.

Read this article for advice on chalking out a clear cash flow management strategy to maintain a robust accounting and finance function and avoid bankruptcy.

Positive cash flow is the key indicator for long-term business growth

Cash flow is the total amount of cash your business currently has coming in and going out as you purchase or sell products and services to and from clients, customers, and vendors.

However, the volume of cash in your business constantly fluctuates based on your expenditures, budget, savings, funding, and other financial factors that come together to create either a positive or negative cash flow.

Poor cash flow happens when your expenditures exceed your budget, and you experience a cash flow crunch.

Maintaining an adequate level of cash (positive cash flow) is a mission-critical priority. It gives you more capital for purchasing inventory, hiring employees, and carrying out successful strategies to retain customers, leading to steady business growth in the long term.

To maintain steady business growth, focus on achieving positive cash flow. However, don’t mistake positive cash flow for high sales numbers, as large cash inflows can be the result of other factors, such as limited expenditure on inventory.

5 strategies for better cash flow management

Here are five strategies you should implement from day one, while devising your small business’s financial plan. Keep reading for detailed recommendations.

Small business cash flow management strategies
 

Small business cash flow management strategies

Accepting multiple payment methods naturally increases cash flow


 KEY BUSINESS CHALLENGE:  Limiting customers to a single mode of payment, whether it’s cash, checks, or credit card, means small businesses are restricting themselves. Adopting new digital modes of payment, such as online and mobile device payments, will naturally generate more cash flow.

More manual methods, such as cash and check payments, must be manually sorted and entered into accounts receivable (AR), which delays the cash flow to your budget.

In addition, customer expectations continue to evolve, as they increasingly adopt new payment methods, such as mobile wallets and near-field communications (NFC), due to the convenience of making payments directly from their smartphones.

Finally, with eCommerce becoming a common platform for financial transactions, customers find online payment easier, especially if they can quickly make the payments through a payment gateway that is linked to their bank account, without having to use their debit or credit card.

 RECOMMENDED ACTION:  Adopting multiple payments modes can help your customers or clients choose their preferred payment method. Here are some ways you can adopt this strategy:

  • Adopt payment methods most suitable to your industry first. For example, if you have a small franchise business, such as a restaurant or coffee shop, consider offering digital transactions such as NFC.
  • Besides only offering credit cards, debit cards, or automated clearing house (ACH) payments, shift to a digital wallet or mobile payment solutions such as PayPal, Apple Pay, Venmo. You might even consider new financial technologies, such as bitcoin.

Poor invoice management practices lead to cash flow gaps


 KEY BUSINESS CHALLENGE:  Receiving late invoice payments from customers and clients will negatively impact your overall profit and loss statement, as late payments will not be included in the current period estimate. Late payments are not part of your closing balance in a quarter or fiscal year, leading to a low opening balance and indicating a negative cash flow.

Moreover, poor invoice management will create a cash flow gap if you don’t have tight control over collecting payments. For example, if you pay vendors within 30 days but give your customers 45 or 60 days, you’ll end up with a cash flow gap.

Small businesses often find it challenging to collect sales invoices as soon as an order is placed by customers or clients, which affects the total amount of cash coming in. However, receiving delayed payments on credit sales will impact the processing time of accounts payable departments and result in lower cash flow volume.

 RECOMMENDED ACTION:  Implement a robust invoice management policy to bridge the gaps in your cash flow management. Here are some strategies you can adopt:

  • Create a policy for dealing with late payments and fast track cash transactions by integrating electronic invoicing with your customer or client management system.
  • Encourage your customers or clients to make electronic payments instead of check or cash to speed up the process.
  • Hire collection agencies to help you collect your due if you have a severe cash crunch; however, that will cost you a commission per payment collected, so it’s ideal if you can proactively avoid late payments, rather than be reactive.

Forecast cash flow for the short term to account for seasonal changes

Forecast cash flow for the short term to account for seasonal changes


 KEY BUSINESS CHALLENGE:  Small business owners or finance managers generally tend to forecast cash flow requirements in the long term, from two to five years. However, seasonal changes in inventory requirements can change sales patterns, which can affect cash flow volume in the short term.

Moreover, a good profit forecast in the longer term does not necessarily mean that you have good cash flow in the shorter term, since your expenditure on inventory can increase over a given period.

Profit should not be the key indicator of good cash flow in the long term, as good sales might increase your profit and revenue in the short term, which might inflate your cash flow temporarily. Focus on expense management to target good cash flow in the long term.

 RECOMMENDED ACTION:  Here are some strategies you can adopt for cash flow forecasting.

  • Conduct a break-even analysis to forecast how much cash your small business will require in the long term. In a nutshell, a break-even analysis helps you monitor fluctuations in fixed and variable costs in relation to your business income.
  • Monitor your income and cash flow statements monthly, or even weekly, to get a short-term analysis of changes in cash flow, which can help you project your cash requirements for the next three to six months.

Example of break-even analysis
Example of break-even analysis. “P” is the point where costs and income are equal, or where they “break-even,” indicates levels of costs (variable and fixed) as business output increases in relation to income. To maintain a positive cash flow make sure income either equals or exceeds your costs. (Source)

Automation provides a bird's-eye view of cash flow

Automation provides a bird’s-eye view of cash flow

 


 KEY BUSINESS CHALLENGE:  Sixty-two percent of small businesses process paper invoices, while 92 percent of small businesses still use checks, both to pay invoices and on the receiving end. Based on these stats, tracking cash flow through your accounts receivable to your accounts payable can become extremely difficult and prone to error, since it requires a lot of manual data entry.

 RECOMMENDED ACTION:  Here are some strategies you can adopt for automating your cash flow management.

  • Purchase online accounting software to manage cash flow. Although many small business can’t afford an expensive ERP system for accounting (especially if you are a small business that is just starting out), cloud-based accounting solutions are an alternative solution that directly helps you automate paper-based invoicing, giving you a broader overview of your cash volume.
  • Adopt cloud-based accounting solutions meet specific requirements of AP, AR, and cash flow management, and are not weighed down with unnecessary features.
  • Choose accounting and finance software with high-end predictive analytics capabilities to accurately predict business cash flow, based on your business’s expense history.

Liquidate obsolete inventory and capital assets to get more cash

Liquidate obsolete inventory and capital assets to get more cash


 KEY BUSINESS CHALLENGE:  While starting up, many small businesses buy up excess inventory (raw materials or finished goods) or capital (computer equipment, machinery, vehicles, etc.) to make the most of the funding they’ve received.

However, the value of inventory or capital depreciates over time, which means you may have to sell the inventory or capital for a lower price than you purchased it for. One option is to liquidate the current value of obsolete inventory or capital by selling it off to get more cash.

 RECOMMENDED ACTION:  Here are some strategies you can adopt to liquidate obsolete inventory and capital assets:

  • Identify movable capital assets, including furniture, vehicles, electronics, refrigerators, machinery, etc. that are costing you more in service and repairs than they add in value, increasing your overall depreciation. These capital assets can be sold off to minimize the effects of depreciation on your small business and generate more cash flow.
  • Prioritize selling-off depreciating inventory or assets that have been in your business for more than a year, but are not adding any value to your business.
Focus on maintaining a higher cash reserve ratio during peak sales season by saving 20 to 30 percent of profit from sales for business cycles with lower cash flow.

Next steps and additional resources

Forecasting cash flow is the key to successful small business cash flow management. However, there are often many factors, such as expense management, sales, funding, and others that can be difficult to calibrate with your cash requirements. Here are some immediate steps that you should take to maintain a positive cash flow:

Cash flow management

Check out the following GetApp resources to help you manage your accounting and finance function to generate positive cash flow: