Poor cash flow management is one of the most common causes of business failures.
Now, that statement might seem a bit obvious. After all, it is clear that a business will fail if the outgoings consistently exceed the income and the cash runs out. But profitable businesses can experience cash flow problems as well.
There is more to managing a small business’s cash than looking at the monthly profit and loss (P&L) report, though. Because what is in the P&L may not mirror what you have in the bank. So, cash flow must be managed separately, and that can be a time-consuming job.
However, keep on top of your cash flow management, and you will be able to navigate your way as you grow your business. You will likely hit some bumps in the road along the way. And you will probably have to juggle vendor payments sometimes. But if your business is headed in the right direction, cash flow blips can be overcome.
If you are an accountant or an experienced entrepreneur, you may know how to manage cash flow. No matter when you started your business, these cash flow management tips might come in handy.
1. Invest in Accounting Software
Accounting software will make the job of managing a small business much less of a challenge. And cloud-based small business counting solutions are available for as little as $10 per month. So, it is not going to be a significant investment.
A good accounting software package will include all you need to manage your business finances. It will allow you to raise and send sales invoices to your customers. And it will provide you with the ability to manage your accounts payable and receivables. Plus, most good accounting packages also include a bank reconciliation feature to help you maintain an accurate cash book.
2. Create a Cash Flow Forecast
To be able to manage your cash flow, you must know what is coming over the horizon. So, the first thing you must do is create a cash flow forecast. There are some software apps designed to help small businesses manage their cash flow. However, if you have a basic knowledge of MS Excel, you would probably be better off using a spreadsheet.
The rows of a cash flow forecast will be the items of income and expense. And the columns will be the periods, which could be weeks or months. In the early stages of a business, when cash may be at its tightest, weekly cash flow forecasting might be more helpful.
3. Forecast Reality, Not Hope
It is best to take a pessimistic view of income when preparing a cash flow forecast. And remember that your cash flow will not match your profit and loss account. You will receive credit from vendors and probably offer credit to your customers, which will cause a time lag between the accounting records and the cash flow.
So, it is best to assume that you will pay vendors on or before the due date while allowing for the late payment from some customers. So, if you grant customers 30 days credit terms, it would be best to assume that cash will materialize in 45 days.
It would also be wise to be cautious about your sales forecasting. Use your most likely sales forecast as the basis for your cash flow forecast rather than your estimate of the best possible case.
4. Look to the Future
Cash flow issues can creep on you slowly. But, if you are aware that a shortage is coming up soon, you can prepare for it and manage your way through it. So, it is advisable to forecast cash forward for at least the next twelve months.
5. Keep the Accounts and Cash Flow Forecast Up to Date
The sooner you know that a cash flow crisis is impending, the better. So, it will help you manage your cash if you keep your accounting and cash flow records current.
If you can, it would be best to update your accounts and cash flow daily or weekly. Doing so will ensure that you know how the business is performing. And keeping on top of the bookkeeping and forecasting will also make the tasks more manageable.
6. Actively Manage Accounts Receivable
Unfortunately, you can’t raise sales invoices and assume that customers will pay. Instead, you will need to be careful about whom you give credit to and actively manage outstanding accounts.
The process begins by credit-checking every customer. And it is also advisable to restrict the amount of credit you offer until you are confident that a customer will pay you on time. Then, raise sales invoices as soon as they become due. And monitor your accounts receivable and chase any overdue accounts as soon as they pass the due date.
7. Keep Inventory Levels Under Control
Stock items on a shelf represent cash that is not in your bank. So, it will be best to keep inventory levels to a bare minimum. Of course, you will need to ensure that you have sufficient inventory to meet customer demand. And you will need to allow for lead times on delivery of stock. Even so, sales volumes for many businesses can be unpredictable. So, it is best to be cautious when ordering any potentially slow-moving inventory items.
8. Avoid Anticipating Income
To some extent, your entire cash flow forecast will be based on income anticipation. After all, you would not be in business if you didn’t expect customers to pay their invoices.
However, a new company will be starting with only a few customer accounts. Therefore, the impact of one late payment could be more critical. So, it is advisable not to commit to any significant outgoings until you are confident that the cash will be available to pay for the purchase.
It would also be best not to assume that one good month of sales will be repeated the following month. Instead, set your expenditure at a level that can be supported by the lowest level of reasonably expected sales. Any anticipation of income could leave you with a severe cash flow problem a month or so down the line.
9. Prioritize Payments
Cash flow can be unpredictable in a new small business. So, even when there is no immediate danger of a cash flow crisis, it would be best to prioritize vendor payments. And there is no need to pay suppliers before the invoices become due.
So, when it comes to paying vendors, run an aged accounts payable report on your accounting system. Then, sort suppliers that are due for payment in order of priority, based on the criticality of those vendors to the smooth running of the business. Pay the critical vendors first, and then use your remaining available cash to pay the due or overdue non-critical accounts as you are able.
10. Maintain a Cash Reserve
It is always best to maintain a cash reserve to cover any unexpected expenditure. Plan your cash flow so that you always keep some financial resources for emergencies.
As your business grows, the amount of cash you will need to retain will grow as well. Your accountant will be able to guide you on the amount of cash you should have in reserve. As your business grows, you can review the level of cash reserve based upon the company’s historical performance.
The best way to ring-fence your cash reserve is to transfer the funds to a separate interest-bearing account at the end of each month. Then, you will earn some extra income on the deposit, and you will be less likely to dip into the reserve.
The Bottom Line
The crucial point to take away from these tips is that cash flow doesn’t manage itself. Indeed, if you take your eye off the ball, even a profitable company can find itself short of cash.
Plan and monitor your cash flow with a rolling cash flow forecast. And be careful to whom you grant credit and be swift to chase any overdue sales invoices. Prioritize vendor payments when needed.
You may have to cut back on spending in some months. And you may need to amend your original business plan. But if you control your cash flow from the outset, it will make the day-to-day running of your business finances much less of a challenge.
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