Understanding cash flow is critical to business success. Cash is the fuel that drives a business, and running out of it will inevitably cause difficulties in continuing business operations. Without sufficient cash flow, you won’t be able to pay employees, meet your financial obligations, and take or create opportunities to grow your business.
The Small Business Administration reported that about 20 percent of businesses failed during their first year. Furthermore, 82% of these businesses experienced cash flow problems and about 29% ran out of cash to keep their operation afloat.
Are you up for the cash flow challenges of starting a business? If so, here are cash flow tips that small businesses and entrepreneurs need to know.
1. Create a cash-flow-based budget.
Budgeting is one of the things that should be at the top of your to-do list to protect your cash flow. Creating a budget will put you on the right track, especially if you are working with limited resources. This will allow you to have an objective look at your financial situation and prioritize the expenses that you really need. Not all expenses are equal, so you will need to analyze the value they give your business versus their cost. If you engage in impulsive buying, especially on unnecessary expenses that do not benefit your business, you will end up hurting your own cash flow.
For the budget to be effective, you need to create it based on your cash flow. This involves tracking where your money comes from and where it is going within a specific period of time. Most importantly, try your best to stick to it. Set realistic numbers on your budget so you have an easier time following it. Aside from this, you should also include a cash cushion that can help you with emergencies. You’ll never know when some business needs and big opportunities will arise in the future so it is important to always be ready when they come. Finally, review your budget every now and then and update it to fit your current business situation. Changes in your expenses and business performance should be reflected in your budget.
2. Get short-term loans to finance short-term needs.
Small businesses need short-term loans more often than long-term financing. These loans usually have a maturity of one year or less. Short-term loans are flexible financial tools that let you address your short-term needs, especially in situations where you need extra cash due to unforeseen problems or to take advantage of business opportunities.
When it comes to short-term loans, small businesses have a lot of options. Banks are the traditional providers of short-term loans. There are also credit unions and agencies that offer short-term loans. Finally, there are also rising fintech platforms which can provide you with quick loans with minimal requirements and with just a few taps on your phone
3. Check potential clients’ credit history.
Extending sales on credit is part of any business operation. By extending credit, you make it much easier for clients to purchase your products and services. Trade credit is one of the ways you can fund this endeavor. With funding from a financing company, you can extend credit to your clients without incurring debts yourself.
But while credit facilitates smoother sales transactions, there will always be a risk of nonpayment. And part of managing your cash flow is minimizing this risk.
Before extending credit to potential customers, you need to first do your due diligence and examine their credit history. Ideally, you want a customer who makes on-time payments. Avoid closing deals with clients with a less-than-stellar credit history. But if you really have to, you can minimize the risk by asking for a higher upfront payment.
4. Don’t be passive in collecting receivables.
Many small business owners are reluctant to contact customers and ask about unpaid invoices. Talking to clients about their unpaid bills is uncomfortable for many and some simply just don’t want to bother and end up writing it off. However, this is a huge mistake and a costly one at that. The more time you take to talk to your customers after an invoice is due, the harder it is to secure payment. So in short, be proactive in collecting past due receivables.
So before anything else, establish a payment system that encourages clients to pay on time. For instance, both you and your clients should be on the same page when discussing the payment terms in the planning phase. This means agreeing when the payment deadlines are as well as the amount to be paid and how they will pay you. This will reduce the risk of wrong information written on the invoice that can cause delays.
Aside from this, impose penalties should they fail to pay on time. A 5% penalty for invoices that are over 5 days due will encourage clients to meet the deadline or risk paying more than they should. Finally, always send gentler reminders to your customers as the payment deadline gets closer. Be professional but stay firm with your words, especially if the bill is way past the deadline.
Inventory actually has a huge impact on your cash flow. After all, a bulk of the business operation is buying material supplies and inventory which then transform back into cash when your product sells or when you are paid for your services. In short, your cash flow largely depends on how you manage your inventory.
One thing that you should look out for is the cost of carrying inventory. If there are poor inventory controls in place and you end up getting more inventory than needed, you may be caught off-guard with the storage costs. In addition, not knowing how often you sell your inventory means you don’t have reliable information on when to reorder and can lead to you missing valuable sales opportunities.
Managing your cash flow is critical to ensuring you are able to grow your business. There will be unexpected circumstances that you will encounter, but with ample preparation and by employing these cash flow tips, you will be able to handle cash flow problems in your business.
About the Author:
Chris Woodard is the Co-Founder ofHandle.com, where they build software that helps contractors, subcontractors, and material suppliers with late payments. They also provide funding for construction businesses in the form of invoice factoring, material supply trade credit, and mechanics lien purchasing.