Skip to main content

How to Manage Cash Flow Problems

business owner reviewing cash flow

Mitigating business cash flow problems should be at or near the top of every small business owner's priority list. After all, while errors in customer service or supply chain management are certainly undesirable, cash flow mistakes have the potential to cripple a business.

The good news is that with some planning and other proactive measures, cash flow issues don't need to be at the forefront all the time. Undertaking some long-term preparation and taking some other key actions can mitigate the problem.

Here is a closer look at cash flow and some key mistakes to watch for when managing this part of your small business.

What is cash flow?

Cash flow is essentially the money that comes into or goes out of your business, including:

  • Payments made or proceeds earned from purchasing or selling investments of the business
  • Money moving between your business and its owners, investors, and creditors

Sales — and the results of sales, your account receivables — play the most important role in cash flow management for small businesses. Without customers wanting to buy your products or services, no matter how much initial capital, loans, or investors you have, your business will not survive.

Remember, cash flow is different from profit. Profit is what you have left at the end of the month or the year after you've covered all your business expenses. Cash flow is the net balance of cash moving into and out of your business at a specific point in time.

Why you need to manage cash flow

The more liquid your cash and other investments on hand, the better prepared you are to manage your short-term business obligations. Managing your cash flow can better prepare you for your business ups and downs:

  • Manage unexpected expenses. Day-to-day small business operations are often unpredictable and your resources might be limited. You can plan for expected overhead such as rent or utilities, supplies, and salaries, but the sudden loss of a repeat customer or unexpected equipment breakdown can throw your business off balance.
  • Keep control of your business. When your business doesn't perform as planned, it can feel as if you're descending into chaos. Managing your cash flow gives you more control and perspective of your business, and helps you make important decisions to innovate, introduce new products or services, or expand into new markets.
  • Apply for loans. Bankers, lenders, and investors usually analyze cash inflow related to operating activities to make a decision about investing and financing your activities.
  • Fund expansion and growth. A positive cash flow also allows you to reinvest and expand, so that you can increase your profits and customer base.

How to manage cash flow

Here are some steps that can help you manage cash flow:

Step 1: Determine your cash flow cycle

You determine your cash flow cycle by defining how long it takes to generate cash from your daily activities. This could be the amount of time it takes to buy parts or supplies, create or manufacture, and sell and receive payment for your products or services.

The shorter the cash flow cycle of your business, the more money you will have on hand to pay expenses and payables and start the cycle once again. If you have frequent cash flow cycles, you're technically more efficient as a business because you can quickly gain a return on your operations.

Step 2: Try to increase the cash you generate per cycle

If your cash isn't tied up elsewhere, then the cash gained from your sales allows you to generate a positive cash flow in every business cycle. To generate more cash per cycle, try to increase your sales, generate larger profit margins, or reduce expenses and salaries — if possible — on each cycle. Or, try to speed up your process to generate more cash flow cycles per year.

Step 3: Ensure your process gives you extra time and resources

Nobody can talk and promote your business with the conviction and the passion that you do. If you spend all your time trying to generate cash in each cycle — applying for financing or loans or looking for investors — you're missing out on generating more sales, promoting or advertising your business, networking, and being out in the community attracting customers that will potentially bring additional revenues.

What are cash flow problems?

Many small businesses fall prey to common cash flow problems. But with an awareness of what some of these problems are, business owners can be proactive in their management of cash flow and hopefully avoid these issues:

  • Anticipating making a profit. Entrepreneurs and new business owners sometimes feel that all they have to do is open a new store or website, and profits will follow quickly. This can lead to overspending in the early days, and the chance that available cash will run out before actual profits begin to accrue.
  • Failing to create the right budget. Generally speaking, a cash flow budget covers the cash a business leader anticipates receiving (usually within the next 30 days), as well as what they gauge is the likely amount of cash needed to pay out during the same time period. Without having such a budget, a business can find itself falling short when it's time to pay bills or compensate employees.
  • Neglecting to consider overhead costs. Expenses for a small business — everything from equipment purchases to worksite leases — can mount quickly. Business owners facing high overhead costs need to look for ways to decrease these costs to make room for profits and a smooth cash flow.
  • Not focusing on accounts receivable. You may be making a slew of sales, but if customers don't pay on time, you could be in trouble. The subsequent lack of available cash can undercut opportunities for growth and increase the difficulty of making your own payments to vendors and others on time.

The dangers of cash flow problems to a new business are obvious. But even established businesses need to monitor how well cash is flowing in and out of the business, so as to avoid encountering some of these and other cash-flow-related problems in the future.

What are the main causes of cash flow problems?

Regardless of their level of financial expertise, business owners should do everything possible to avoid cash flow problems. Here are key mistakes to watch for and ways to strengthen your business's cash flow status:

  • Don't confuse sales figures with cash flow. It's a common misconception: sales equals cash in the bank. In fact, bringing in sales does not necessarily indicate that a company has funds on hand to pay bills when they're due. As noted below, sales only pertain to cash flow when you've been paid for your products or services.
  • Don't fall prey to poor planning. Successful small business owners don't "wing it" when it comes to cash flow management. They create cash flow projections based on a close analysis of how they expect sales to look over the next 12 months, as well as how much cash is likely to be paid out over the same time frame. Looking back over the past year's performance, they prepare cash flow statements that signal if the business made or lost money from normal operations, if the company borrowed money, if it lent money, how much debt it paid back, and other factors. This type of cash flow analysis represents an essential source of financial data, particularly for seasonal businesses and those whose cash flow is often erratic.
  • Don't mistake a sale for positive cash flow. A customer purchases your products or services but isn't necessarily obliged to pay for those goods immediately. In such cases, it's a glaring bookkeeping error to equate that sale (essentially, an unpaid invoice) with money in the bank. Positive cash flow occurs when you're paid for the transaction.
  • Do everything possible to forestall delay of payment from customers. If possible, request terms of immediate payment or no longer than 10 days. You can facilitate "immediate payment" by the use of checks, credit/debit cards, or various electronic payment systems. Consider granting your employees the authority to accept payment through a customer's mobile device. Acceleration of paid invoices is key to favorable cash flow management.
  • Don't overextend your available inventory. Optimistic business owners sometimes order an abundance of inventory they expect to sell in a given time period. But over-ordering products could mean wrapping up funds in unnecessary inventory. This can be especially troublesome if your liquidity is negatively impacted. Idling inventory can siphon off funds that you might otherwise use for new product development or refined marketing strategies. Make sure you have a clear understanding of probable inventory needs over the coming months.
  • Don't leave yourself without a cushion. While a business owner need not assume the worst is going to happen in the future, something unexpected could occur — in which case, money on hand may be the best defense. Even a small cushion for discretionary expenses or unexpected items keeps a budget flexible as business conditions change throughout the year.

To mitigate these problems in your business, consider using online accounting software to help pay bills, invoice customers, calculate and file taxes, and share financial data with an accountant.

Effective cash flow management techniques

Find effective systems for receiving payments

Sometimes cash flow management issues are a result of a business not receiving payments for their goods and services. Fortunately, there are ways to fix this.

One consideration business owners might explore is reevaluating their payment structure. For example, find ways to place customers and clients on a monthly retainer package instead of having them buy one-off products and services.

Another consideration that might help business owners is assessing the credit worthiness of the customers that you do business with. By doing this you may be able to better understand their ability to pay you.

Auto-invoicing and auto-billing can also be beneficial in helping business owners receive payments. Automatic invoicing refers to the use of accounting software that sends invoices for you. Many current accounting software solutions today can also send automatic reminders if you haven't received payments by a certain date.

Auto-billing refers to clients and customers agreeing to be charged automatically on a recurring basis. This works best for retainer services, and services like PayPal or most e-commerce systems can do this for you.

Business owners may also want to consider invoicing more often. For instance, instead of invoicing once a month, they may want to consider doing it on a bi-weekly basis. This helps ensure that there's always cash in the business account.

Review your expenses regularly

Just like people who manage personal budgets should keep an eye on creeping expenses, so should business owners. If business owners are not careful, expenses can creep up over time and possibly even overrun a business.

One way that business owners can audit their expenses is to see whether a certain expense is producing enough return on investment (ROI) to keep it. Granted, if you just invested in new software or a new hire, you'll need to give it some time before you know the answer.

Business owners should also take time to thoroughly consider any potential investments and expenditures. For example, do you need a new website now or can it wait? By thinking an investment through rather than spending and figuring out how to pay later, business owners can mitigate future cash-flow management issues.

While cash-flow issues can be a leading cause as to why businesses fail, there are ways to stay on track with your finances. By using the tips outlined here, you can better manage the cash in your business over time.

How cash flow problems lead to business failure

Determining how cash flow problems lead to business failures can save business owners from making costly mistakes. Just as importantly, knowing the effects of cash flow problems can help prevent them.

Poor cash flow makes it virtually impossible for a business to invest and grow. There's no cash to put into new product development, key marketing activities, operational overhead expenses, and, perhaps most urgently, no money with which to pay employees.

At that point, the very existence of a business can be put in question.

How to fix cash flow problems

Startups must develop strategies to ensure a robust cash flow to help with growth. While business owners can replenish cash flow with strong business sales, there are also some lesser-known strategies they can employ to make sure they have the resources they need.

Revamp receivables management

When a new business makes a major sale, it doesn't necessarily mean it's flush with cash. Depending on the structure of the transaction, some firms will only see a small up-front payment if they offer long-term payment plans.

However, a solid receivables management plan can boost cash flow. One strategy owners use in this regard is to encourage larger down payments. One effective course of action is to offer discounts for larger initial payments. This can make customers more likely to make a greater up-front payment for goods or services.

Providing discounts for early payment can also be useful. This way, owners can budget more effectively and decrease the chance that customers miss payments.

Don't jump at the chance to pay your bills

You want customers to pay their bills in rapid fashion, but in your own situation, it might make sense to hold off on paying bills until necessary. Getting payments out of the way is tempting, but it reduces the time in which a business has access to capital. If an emergency occurs, that reserved funding may be important.

Owners should carefully read invoices from suppliers to determine when exactly their payments are due. Then, they should create a payment schedule that allows them to hold onto their money for as long as possible.

Go paperless

Switching over to a paperless format for invoicing and payments can reduce a company's paper and printing expenses. There may be some initial investments associated with implementing the technology to go completely paperless, but businesses should see a positive return on investment in the long run.

Maintain a cash cushion

Much like a personal budget, small businesses should keep a certain amount of cash on hand in case of emergencies. Maintaining adequate liquidity is important, but reserving too much cash may cause businesses to miss out on profitable investment opportunities. Industry or regulatory standards may also play a role in determining a minimum cash reserve.

Track the cash account

A statement of cash flows illustrates how much cash goes in and out of the business each period. You can get more extensive tracking via a cash journal, which is an even more detailed record of company transactions. To gain awareness of how money is being spent, reports should be reviewed and exceptions to normal expenditures noted.

Reconcile cash accounts to bank statements

You should reconcile cash balances to an external source like a bank statement. Review balances on a regular basis, and investigate any discrepancies. Establish separation of duties between those who handle cash and those who record transactions to mitigate misappropriation or employee fraud.

Enforce late payment terms

Once you establish a customer base, make sure you receive payments on time. Late payments affect the cash cycle and may cause companies to find themselves unable to pay their own bills from vendors and suppliers. To reduce cash flow problems, follow up with late customers on a timely basis, and enforce the late payment terms written into contracts.

Key cash flow management techniques

These additional cash flow management techniques can help your business stay afloat:

Obtain a business credit card. Having access to different lines of funding can help cushion your cash flow.

Request a deposit or partial payment. When it comes to orders of a significant size or the possibility of a long-term contract, consider requesting a 5 or 10% deposit prior to the start of the project. When work gets underway, charge half of what remains on the account, with the balance due after completion.

Explore mobile payment solutions. There's a variety of mobile payment apps that leverage the power of your smartphone or tablet to accept a client's invoice payment by credit and debit card.

Obtain a business line of credit. Consult your bank or loan organization about the viability of obtaining a business line of credit. This helps extend your cash flow resources when they are needed most.

Lease instead of buy. Equipment purchases can be enormously expensive, and there are always costs associated with upkeep and maintenance. Look into leasing digital technology, other types of equipment, and vehicles. Leasing costs are often tax-deductible.

Maintain a cash flow forecast. Look ahead six to 12 months. What targets should you aim for, in terms of growth, while keeping cash flow intact? Are any seasonal factors involved? Do expenses rise during a particular time of year? What fixed costs can you anticipate? What about variable costs? Draft a cash flow forecast that's as comprehensive as possible.

Discovering the best ways to avoid cash flow issues in business and maximizing cash flow is important in setting up a new business (and keeping an existing business afloat). As an organization continues to grow, knowing how to manage your small business finances and fix cash flow problems will help your company weather the inevitable ups and downs of the business cycle.

We can help you tackle business challenges like these Contact us today

* This content is for educational purposes only, is not intended to provide specific legal advice, and should not be used as a substitute for the legal advice of a qualified attorney or other professional. The information may not reflect the most current legal developments, may be changed without notice and is not guaranteed to be complete, correct, or up-to-date.

Recommended for you

About Paychex

Paychex was founded over four decades ago to relieve the complexity of running a business and make our clients' lives easier, so they can focus on what matters most.

We provide: