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How to Mitigate Business Cash Flow Problems

Even if you have extensive financial expertise, business owners should do everything possible to avoid cash flow problems. Here are some key mistakes to watch for and ways to strengthen your business’s cash flow status.
business cash flow

Mitigating business cash flow problems should be on 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.

Cash flow is essentially the money that comes into your business, including:

  • Beginning cash or bank balances, plus any petty cash on hand
  • Interest earned from bank accounts and investments
  • Business loans or lines of credit

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, 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 all your business expenses have been covered. Cash flow is the money you have at any given time to keep your business in good standing.

Why you need to manage cash flow

The more liquid your cash flow, the better prepared you are to face your business ups and downs. In addition to keeping your business afloat, managing your business cash flow can also help you with other situations:

  • 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.

Your cash flow cycle is determined by the amount of time it takes to buy parts or supplies, create or manufacture, and sell and receive payment for your products or services. It essentially defines how long it takes to generate cash from your daily activities.

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.

Common cash flow management mistakes

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' 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 payment for your products or services has been made.

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.

cash flow issues

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. "Immediate payment" can be facilitated 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 might otherwise be used for new product development or refined marketing strategies. Refer to your detailed cash statement for a clearer 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 cash flow problems in your business, consider using online accounting software to help them pay bills, invoice customers, calculate and file taxes, and share financial data with an accountant.

cash cushion

Effective cash-flow management techniques

Here are two cash-flow management techniques business owners should consider:

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 may need to take is reevaluating their payment structure. For example, they can find ways to have customers and clients on a monthly retainer package instead of having them buy one-off products and services.

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

And finally, business owners may 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.

Strategies to increase cash flow at startups

Startups must develop strategies to ensure a robust cash flow to help with growth. While cash flow can be replenished with strong business sales, there are also some lesser-known strategies that owners 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 the determination of 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. More extensive tracking can also be achieved 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. Customized cash flow reports may be designed through a cloud accounting system.

Reconcile cash accounts to bank statements. Month-end cash balances should be reconciled to an external source like a bank statement. Balances should be reviewed each month, and any discrepancies should be investigated. Separation of duties should also be established between those who handle cash and those who record transactions to mitigate misappropriation or employee fraud.

Enforce late payment terms. Once a customer base is established, make sure payments are received 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 in to contracts.

Discovering the best ways to maximize cash flow is one of the important steps when setting up a new business. As an organization continues to grow, cash flow should continue to be monitored. Striking a balance between investing cash in business opportunities versus maintaining a liquidity cushion for unexpected events will help a company weather the ups and downs of the business cycle.

Managing your small business finances isn't a skill you can put off acquiring until the time is "right." Too many enterprises flounder when the owner focuses their attention on other things, because company financials aren't especially exciting to contemplate.

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* 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.

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