Controlling Cash Flow is Essential to Success
Small businesses are often strapped for cash. A critical business imperative is to control cash flow and not just manage it.
As any business matures, various factors affect cash flow, some being growing operating costs, direct product costs (cost of goods), staffing/labor, product and service pricing as well as invoice and payment terms. Apply a few simple but effective principles for controlling cash flow and one result will be that you really understand your business. Two major categories impacting cash flow are, quite simply, cash-in and cash-out. Controlling cash flow requires managing both.
Following the Flow of Cash In
First, cash in is about being paid for the services and products you provide. When you are closing business with clients and customers it is important to talk about terms of payment. Often sales people do not want to talk about this because they think it will impact actually closing the sale. Good business practices require that clients and customers know and adhere to your invoicing and payment schedules. Some businesses run exclusively on payment after delivery of product or services. This payment schedule may be appropriate for a bakery or boutique clothing store, but it means the business carries operating costs until the product or service gets sold. These businesses are always “chasing cash”. Other business models have an upfront payment so you are delivering business with customer money. Depending on the product or service, many companies bill every two weeks or by the month based on “percent complete”. Also look at your terms of payment, which is the time from a customer’s receipt of the bill to when you receive payment; net 30 days is common or net 15; payment upon receipt of bill is also used.
The smaller the business, the more these terms need to be short. Evaluate standard terms within your business sector but adjust terms to what your company needs. If your business has other businesses as clients (referred to as B2B), find out what their payment policy is and get agreement on what works best for the circumstance. Put a follow-up system in place to contact clients as soon as they have gone beyond payment terms. Establish a reputation for managing your invoice payments. Companies and clients respect this good business practice.
Get into the Details of Cash Out
Cash out is about paying all your bills and your employees. A good exercise is to map the cash flow out on a monthly calendar. Do this over several months to establish your cash position on a daily or weekly basis. The smaller the business the more tightly you need to manage by day, week or month. Also have a budget based on actual expenses, not an “I want my budget to look like this” budget. Think of the budget as being “fully loaded”, which means everything is in the budget. Manage the business on a budget line-by-line basis and on a daily, weekly or monthly cash flow calendar. If there is an expense or line item that does not make sense to you, look for the details. When your miscellaneous line item gets too big and you do not know what is in it, break it up into new expense categories.
Once you have this level of detail, you can look for ways to control cash out. For example, if there are time periods such as the third week in the month, that you are consistently low on cash, consider renegotiating some of the terms of your payables. You may find adjusting just a few payables to different times in the month can alleviate the low cash cycle. Changing the pay period for employees from monthly to bi-weekly (or vice versa) can have a significant impact on cash flow.
Financing Options for Cash Flow Gaps
Companies facing a cash flow squeeze and slow-paying customers often sell their invoices or accounts receivable to invoice factoring companies. The invoice factoring company (factor) advances a percentage of the invoice amount—anywhere from 80-95%--depending on the creditworthiness of the billed customer. When the invoice is paid, the factor pays you the balance, minus a transaction or factoring fee.
Companies that use factoring like it because they get funds quickly rather than waiting 30 or 60 days for payment from their customers. After sending an invoice to a factoring firm, a business can have money in its hands usually within 24 hours.
At some point you may see the need for a line of credit. Develop a good working relationship with financial institutions is essential. Banks are much more likely to work with you when you have a solid budget, financial details and a good track record. Good cash flow management can include using a credit line wisely. The objective is not to accrue debt, but to move money in and out of the credit line to manage your business.
The Bottom Line
Controlling cash flow is absolutely critical to running a successful small business. The more details you have about day-to-day and week-to-week cash coming in from invoices, and operating and labor costs going out, the better you know the business and where to focus your management time.
Watch this video to learn how Universal Funding can finance your company’s growth without the wait.
About Universal Funding
Universal Funding is a private funding source that has funded thousands of businesses and more than $2 billion since 1998. We turn your accounts receivable into the funding you need through invoice factoring and can have capital in your hands in a matter of days.