Why Small Business Cash Flow Management Matters

by Kieran Daly
November 14, 2023
Why Small Business Cash Flow Management Matters

Even if a business is super-profitable on paper, it can quickly collapse into bankruptcy. Often, the main reason this happens is that customers don’t pay their bills quickly enough. This is why effective small business cash flow management is so important.

You can’t pay staff, buy raw materials, sign office rental leases, or book advertising with money outstanding on invoices. You can only settle your bills with the money your customers pay you.

It’s critical to get your small business cash flow management right — your business will be stronger for it. In this article, we cover:

  • What cash flow is and how it’s different from profit and loss

  • Why cash flow statements are important and what they mean

  • How to turn your cash flow statements into cash flow forecasts

  • How to make the most of your cash flow forecasts

What Is Cash Flow?

At its simplest, cash flow is how money moves in and out of your business bank account. It’s a reflection of all your business’s cash transactions.

Cash inflows are the money you receive from your customers, including cash sales and collections on credit accounts. Cash outflows are the money you pay to your suppliers and your staff, and the money you pay toward taxes, business financing, and so on.

How Is Cash Flow Measured?

Some companies measure cash flow by the month, and others measure it by the quarter. The period of time you choose for your cash flow management should reflect your trading or financial activity cycles and your tax reporting requirements.

If your business’s cash reserves go up in the period of time you’re monitoring, you have positive cash flow. If your business’s reserves go down, you have negative cash flow.

Entrepreneurs and business owners should, of course, aim for a positive cash flow. This is a sign that the financial health of your business is strong.

The more money you accumulate in your bank account, the more working capital you have to meet your normal business expenses without having to borrow money or delay any payments.

Is Cash Flow the Same as Profit and Loss?

“Profit and loss” is an accounting term that refers to the difference between what you’ve invoiced to customers and what you’ve paid out to suppliers, employees, landlords, and others.

Profit and loss calculations are based on something called accrual accounting. With accrual accounting, you record revenues and expenses on the date you make or incur them, not when cash is exchanged. So a profit and loss statement doesn’t reflect the actual cash that you have.

So, for example, if a business sends out a lot of invoices and doesn’t get paid on them quickly, they may not have enough cash to pay their bills. They may have great profit margins on paper, but they could also be insolvent at the same time.

Cash flow, on the other hand, measures the actual amount of cash that gets transferred into and out of a business.

Even businesses that get paid quickly and are profitable can have periods of negative cash flow. That often happens if they make a large and strategic investment in equipment or machinery. These investments are sometimes called capital expenditures.

At all other times, their cash flow may be positive, though, so one period of negative cash flow is not necessarily something to be concerned about. But if a business suffers negative cash flow over multiple consecutive periods, it will become insolvent at some point.

What Is Small Business Cash Flow Management?

Small business cash flow management is how you track, analyze, and optimize the cash coming into and leaving your company.

A lot of having a positive cash flow comes down to timing, especially for small business owners. To avoid cash flow problems, you need to figure out how to get money into your company before you need to pay out on business expenses.

If you can accomplish this, then this decreases the likelihood of your business experiencing a shortfall in the amount of money you need to run your business operations.

You will be more likely to meet your financial obligations in time and, assuming you’re profitable, will be able to save up cash to invest in growth opportunities.

How Do You Track How Well You’re Managing Cash Flow?

The best way to track the status of your small business cash flow management is to update and refer regularly to a cash flow statement.

A cash flow statement offers a snapshot of your financial situation at a given time. It’ll show the money you’re getting from sales, services, and other income sources and will also indicate the cash that’s going out for expenses, purchases, taxes, and loan repayments.

How Do You Create Cash Flow Statements for a Business?

You can generate cash flow statements using bookkeeping and accounting software like Xero or QuickBooks.

Your accounting software can sort the transactions you enter into it into accrual or cash transactions. You can then use the reporting feature on your software to isolate cash transactions to get a snapshot of the real-time cash status of your business.

To optimize your cash flow statements for the most accurate results, be sure to take the following steps.

  • Enter every new cash transaction: Your software will keep a record of everything you input and will update your cash flow statement accordingly.

  • Set reminders: Use your accounting app to remind you when payments are due in or out to help you avoid unpleasant surprises.

You can then use this information from your cash flow statements to generate cash flow forecasts. With a forecast, you’ll get an idea of how much will be in your bank account on a given day, week, or month in the future.

You’ll be able to use this projection to make certain decisions. For example, you’ll be able to see when your bank balance will likely be large enough to put down a deposit on a business loan to purchase equipment and machinery you need to grow, while still having enough to meet your standing outgoings. Conversely, you’ll see when you have to tighten your belt when there may be a time of low income and high outgoings.

To keep your forecast up to date and make it as useful as possible, make sure you follow these three rules.

1. Review regularly: Keep on top of your cash flow at all times by reviewing your cash flow statement at regular periods, for example, once a week.

2. Make adjustments: If a payment doesn’t arrive or you receive an unexpected bill, update your cash flow forecast to reflect this.

3. Plan for what-ifs: Some accounting software packages allow you to experiment with debtor days. Debtor days is the average time it takes for your customers to pay you. This feature lets you forecast how your cash flow will be affected if clients start paying you late.

6 Ways to Reduce the Chances That Your Business Will Run Into Cash Flow Issues

Your cash flow forecast, together with the other functions of your accounting software, will give you actionable clues on what you need to do to make your business more resilient.

Here are six guidelines many successful entrepreneurs follow to improve their small business cash flow management.

1. Put a Stop to Late Payment Issues

Late payments kill businesses. To see if this is an issue for your company, check your accounting software for the following.

  • Debtor days: This feature estimates how long each client typically takes to pay their bills.

  • Higher-risk clients: Flag accounts with a history of late payments, and then run a new credit report on these clients to assess how much credit you should be advancing them. Change credit limits or ask for a sizable deposit or upfront payment in full if necessary.

If the answers your software provides don’t make for comfortable reading, there are a number of approaches you can take.

  • Agree on payment terms upfront: When a new client comes on board, clearly tell them what you expect of them.

  • Invoice right away: As soon as a job is done, invoice your customer for it straight away. Include your payment terms clearly on every invoice you send out.

  • Offer multiple payment options: Many accounting software packages now allow you to embed links so that clients can pay you online via a personal or business credit card or debit card.

  • Get organized: Set up a structured accounts receivables collection process for overdue payments, like contacting the customer on the day the payment was due and every three days after.

  • Offer discounts: Give clients an incentive to make early payments with money off, but be careful not to be too generous — that will mean you won’t make enough profit.

  • Set up factoring: Invoice factorers pay you up to 90% of the invoices you issue with the remainder, minus their fee, when your client settles up.

2. Consider Diversifying Your Income

Being too reliant on a handful of clients puts you at risk. Check the following on your accounting software.

  • Income concentration: Find out what percentage of your total income comes from each client.

  • Sales trends: Analyze your sales history to look for potential overdependence on particular clients over time.

If the withdrawal of one or more of those customers would mean that your business doesn’t break even or make a profit anymore, you need to de-risk. To do that, take the following approaches.

  • Invest in marketing: Promote your business to potential new clients, and try reaching out to decision-makers and buyers in new sectors where your products and services would have appeal.

  • Develop complementary products and services: Identify what customers currently order the most to see if there are add-on products and services that would bring extra value to your overall package. This can increase your profitability and make it less likely your customers will switch to a competitor.

  • Sell bundled products: You can create tailored packages of products and services to meet individual clients’ specific business needs.

  • Financial health metrics: Run regular credit reports on important clients to make sure they are not at risk of insolvency. If there is a risk, prioritize finding new clients to give yourself the best chance of achieving your cash flow projections.

3. Look at Your Pricing

You need to charge over and above what you pay to deliver products and services to customers to make a sustainable profit. Consider the following.

  • Competitor pricing: How much are rival companies charging, and how do their packages compare to yours?

  • Profit margin analysis: Use your accounting software to determine what your current level of profitability is.

If you conclude that you can charge more and that you should be making more money, the following steps will help.

  • Analyze price elasticity: Some accounting software add-on apps allow you to forecast demand based on pricing, showing you the estimated level of demand for a product or service depending on whether it costs more or less. You can use that information to decide on the price that makes sense to charge and adjust your advertised prices accordingly.

  • Inform existing customers of the changes: Be transparent with customers, making sure you justify any price changes by highlighting the benefits they’ll continue to receive when you notify them.

  • Introduce tiered pricing: To counter any blowback against price increases, consider introducing tiered pricing so customers have more choice on the products and services they actually want.

Of course, it’s always easier to lower prices than to raise them. However, given a choice of servicing 100 customers for $1 million or 50 customers for the same revenues, the latter option is, for many businesses, the more sensible choice.

4. Prune Your Outgoings

Paying less to your suppliers and providers is, like bringing in more sales, a way to increase profitability. To see if you can streamline your spending, check the following.

  • Supplier expenses: Go through your list of suppliers to see if you really need everything they sell to you.

  • Inventory levels: Inventory management is also important, as buying stock ties up your cash.

  • Recurring costs: Many companies, for example, take out subscriptions, use them for a short time, and forget about them.

If you can find areas to cut spending, take these steps.

  • Negotiate on price: For important suppliers whose products and services you need, see if you can get better prices.

  • Negotiate on payment terms: Try to only pay money out once you’ve got the money in. First, see if you can get your customers to pay you within a set window, for example, the last week of the month. If that’s possible, then talk with your suppliers to ask them if you can settle your bills with them the following week, explaining how doing this will make your business’s cash flow stronger and its future more secure.

  • Improve inventory management: Try to ensure you don’t carry too much stock, and consider using inventory financing to fund larger orders. Many accounting software packages now have just-in-time (JIT) inventory apps that may be of use, too.

  • Cancel unused subscriptions: Take a straw poll of everyone in the business to see if they really need the apps you pay monthly for. Jettison the ones that you don’t need.

5. Start a Rainy Day Fund

Business is anything but predictable. Unforeseen events like a legal threat can quickly destabilize the finances of any business.

Take the following steps to mitigate the risk.

  • Set up tax “pots”: Many online banks in particular allow businesses to create pots of money for a defined purpose within the same account. So you might set up a pot for sales taxes and another one for business taxes. By doing this, you’re not using the money you owe to the government for daily use.

  • Set up a savings pot: Use this one for your savings. Try to make your first goal the accumulation of at least two or three months’ worth of reserves.

  • Set up allocations for each pot: When money is paid into your account, program your banking app to transfer a percentage of the cash to each pot.

  • Leave your pots alone: Until you need to pay taxes or the rainy day actually comes, don’t touch the money that’s in your pots, and consider the balance in your checking account to be your only source of available funds.

6. Stick to a Budget

Having a budget and sticking to it is important. Your budget, together with your business plan, is your road map for survival and growth. Look out for the following in your accounting software.

  • Budget vs. actual costs: How does your actual cash flow compare with what you budgeted in your business plan?

  • Expense tracking: Within your budget, you’ll have allocated a certain amount of expenditures for different types of products and services. Are you sticking to your forecasted spending in each of those categories?

If you’re not spending to plan, take the following actions.

  • Review your budget: Your forecasted spending may have been unrealistic given the amount of business you’re doing. Review, and adjust your budget accordingly.

  • Look for root causes: Find out why you’re over- or underspending on individual categories in those areas where you did not adjust your budget.

  • Monitor regularly: Make sure that you run this analysis and review your budget regularly (monthly or quarterly) to adjust for unforeseen expenses and any investments you make in your business, like purchasing machinery, equipment, and so on.

What Financing Options Are Available to Businesses With Cash Flow Difficulties?

While your balance sheet might look great and your profit and loss figure may be impressive, we’ve seen that how much cash you have in the bank often counts for more.

Even the most experienced entrepreneurs are subject to unexpected cash flow surprises, so you should do as much as possible to prepare for them. Having a rainy day fund, following up with customers who owe you money, aligning when you pay your suppliers with when you get paid, and sticking to your budget will give your business the best chance of surviving and thriving.

Two options for companies seeking help with their small business cash flow management are Backd’s working capital advance and business line of credit.

Our working capital advance option offers business customers up to $2 million. You could also apply for a business line of credit with a limit of up to $750,000. Once you apply, you’ll have your answer within 24 hours, and you won’t need to provide any collateral like with many other types of business finance options.

It only takes a few minutes to apply, and you can get your decision by the next business day. Apply with Backd today.

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