8 Critical Cash Flow Rules
Did you know…
- Small businesses in US cite cash flow as one of their top 5 challenges
- 82% of failed small businesses failed due to poor cash flow management
- From an analysis of 101 failed startups, 29% were found to have failed due to lack of cash
For any entrepreneur, these figures paint a grim picture of the business environment. No-one starts a business with the expectation that it will prematurely die—though there is always the fear of that possibility.
But such stats should not cause you too much worry, just concern.
And with the knowledge you’re about to gain, you’ll at least be better off and can make better decisions. The same way big businesses started small and are doing well, so can yours.
With good cash flow management being a critical factor in running a successful business, here are some principles to guide you.
First, let’s get some basics out of the way.
Positive vs Negative Cash Flow
Cash flow can be either positive or negative. Your business is better off when running with a positive cash flow.
Cash flow is positive when the amount of money coming in is more than that leaving the business.
Money coming in will be through your receivables while that going out is through your payables. Receivables are mainly sales plus other revenue-generating activities your business is involved in.
Payables are all the expenses you incur including external payments to lenders as well as internal ones like salaries.
If you realize that your cash flow is negative, it’s time to do some work. Negative cash flow can result in serious business problems.
Working Capital vs Cash Flow
One term used almost interchangeably with cash flow is working capital. Although the two are connected, they are very different.
Your working capital tells you the overall strength of your business in the long-term. Cash flow on the other hand tells you about the short-term status of your business. Long-term in this case refers to more than 12 months and short-term is less than that.
From an accounting point of view, working capital is calculated by subtracting your liabilities from your assets. The more your working capital, the more assured you can be of the profitability of your business.
But working capital is not all you need to look at. Considering the above-mentioned statistics, cash flow is a major factor to consider.
As much as it concerns the short-term, it is that short-term that can adversely affect your business.
Money will flow in and out of your business on a daily, weekly or monthly basis.
But if this flow is not well balanced and managed, the business might not exist for long enough to achieve your long-term goals.
Just think about what could happen if you cannot pay your rent and salaries for four consecutive months.
Won’t this affect your business negatively?
You might as well be kicked out of the premises you’re running your business from. And that is assuming your employees will be waiting all this while.
CASH FLOW RULES FOR A SUCCESSFUL BUSINESS
We would like to help you avoid being one of the businesses not succeeding due to cash flow problems.
For this reason, we prepared this article to guide you on the things to keep an eye on.
These seven rules will give you the ability to handle your cash flow better. With good cash flow management, you’ll have a thriving business.
1. Cash is Really King
You have heard this before. And it’s very true.
The abundance of cash in your business provides numerous opportunities. In a similar way, the lack of it spells doom.
The number of businesses affected by poor liquidity management are many.
The key to understanding the importance of being liquid is to remember that you have periodic payments to make. Such payments are made from cash. And cash is different from sales.
Many business owners tend to confuse between revenues and cash. These two are different.
Revenues are simply a note of the transactions done. Only when you’re paid for those transactions do you count yourself as having received cash.
2. Profits and Cash are Different Things
Following the above point, profit figures can also be misleading to the less experienced business owner.
If you’re struggling with these two terms, a simple differentiation is that profits don’t pay bills but cash does.
Because profits do not necessarily equal cash.
If you take a look at your P&L (Profit and Loss) report and decide that you have enough money to run your business, you’ll be wrong.
The reason is that profits as per the P&L report come from sales made without payments being received.
Profits are therefore not the best measure of your financial status as a business. Unless you’re looking at the bigger picture, get a cash flow summary and make decisions based on that.
3. Increase in Inventory Means Decrease in Cash
One of the things you may be looking for as a business owner is more sales. This is a good thing and certainly worth pursuing.
If you sell tangible products and want to have more stock for the expected increase in sales, good.
Ask the production team to increase production.
Empower your sales and marketing teams and urge them to work towards more revenues. But as you do so, note that it’s going to cost you.
The cost may not be direct but it will certainly show in your cash flow summary.
As you pump out more goods, either by producing or buying more from suppliers, there is a cost attached.
The more inventory you have lying in your store or warehouse, the more your cash flow is stuck.
Every product bought or produced costs money. That money has been spent from your cash as an expense. As more cash flows out of the business, will you be having a positive or negative cash flow?
As long as expenses are higher than incomes, the situation needs correcting.
4. Always Make Cash Flow Projections
One way to stay safe is by making cash flow projections. This is like planning ahead of any activity.
And just as planning is essential and helpful in anticipating challenges, so are cash flow projections.
Making cash flow projections will help you recognize potential problems before they show up.
With the projection, you’ll be having a map of where you want your business to go.
If after 1 month you’re not where you expected to be, then you can take a closer look to identify the problem.
Without a projection, it’s impossible to do this since you have nothing to use for comparison.
In making a projection, you might be tempted to make one and keep it in your mind.
This can feel and sound like a quick way of going about it but it’s not the best.
It would be best to engage your finance team and other managers to discuss this. If you’re the only employee of the business, then you’ll do it alone. But the important thing is to draft the projection and have physical copies at hand.
You can have several in relevant files, even in the cloud for access from anywhere.
5. Always Know Your Cash Balance
How fast can you make a business decision? And how good will that decision be?
Good decisions are made when knowledge is available. Great decisions are made when insights are available. And the best decisions are made when you understand the whole situation.
If cash flow problems are big enough to cause businesses to close down, then you should always be on top of things. You may not be the accountant but he reports to you. If you have a big finance department, then the FC might be the one reporting to you.
Whichever the case, you need to have some financial data on your fingertips.
As the business owner, you’ll be interacting with other business owners or company representatives who are decision makers. If you spotted a good business opportunity, how long would it take you to make a decision?
If you’ll need to call your accountant for updates or check the latest report, someone else might get an advantage.
The ability to make sound business decisions is determined by how much you understand your business and the factors affecting it.
Your should know your cash flow balance. If your business has many daily transactions, you can ask to be updated twice a day. If they are few, maybe twice a week. Whichever schedule you set, just keep those numbers close.
6. B2B Business Strains Your Cash Flow
If you run a B2C business, you may not be affected much by this. But if you’re in the B2B business, then keep this in mind.
Any time you sell to another business, your cash flow is at stake.
This doesn’t mean that you should cease B2B operations. It just means that you should be smart about them.
Unlike where you sell directly to consumers and they pay you immediately, selling to other businesses means you wait for the payment.
You will deliver or they’ll pick up goods then get an invoice. The invoice will be paid after 30 days, 60 days and in some cases, later than that.
This can be a major challenge if you don’t have enough cash to sustain your operations.
Whereas there isn’t any automatic solution to this, there are steps you can take to counter this. More on this in the section about managing your cash flow.
When making your cash flow projections, take this into consideration. Plan for the potential delays in receiving payments so you don’t expect too much then get disappointed.
7. Business Growth Doesn’t Solve Cash Flow Problems
As an entrepreneur, you want your business to grow and flourish.
And since cash constraints can hamper growth, you may think that growing your business will solve any cash flow problems you might have.
Well, that’s wrong. In fact, it may make things worse.
Business growth requires cash. And if you’re cash-strapped, then growth may not be possible.
However, you can get external funding like loans, and that is a better way of going about growth.
But if you insist on using cash to expand your business, you’ll end up in big problems.
If you have cash flow problems, look for solutions from right within your business.
Get the data and take a close look at it. You’ll likely spot issues which when dealt with, will release so much cash into your hands.
It all boils down to reducing your periodic expenses while increasing your incomes.
TIPS FOR MANAGING YOUR CASH FLOW
Since it’s all about having more income and less expenses, what better way of helping you other than giving you some tips to implement?
The management of cash flow requires some smart thinking.
The good thing about smart thinking is that anyone can learn. This is like many other things in life, e.g communication skills, which can be learned by anyone.
Here are 9 tips which will help you manage your cash flow like a pro.
1. Monitor Your Cash Flow
Always monitor your cash flow. This is the only way you’ll be able to detect issues early enough. And the sooner you detect them, the easier it will be to solve them.
To do this, keep an eye on your periodic expenses and cash inflows. Stay updated on major transactions in your business.
You can set the limit for your finance team and ask them to notify you about any payable or receivable above a certain amount, e.g $500.
This should be in addition to receiving regular updates, like weekly or monthly, depending on your preferences.
2. Get Paid Faster
Now here is a trick which may have been played on you without you realizing it.
Have you ever been told by a supplier that if you pay on time you’ll pay less? Did you pay on time in order to save some money?
No harm if you did. But just know that you fell for a trick. And just to be clear, it’s not a bad trick. It was just a case of someone acting smart. And you’ll also learn how to do the same.
Realizing that less money in his pocket now is better than more money in his pocket 2 or 3 months later, the supplier gave you a discount. While you looked for savings and went for the deal, he was looking for faster payment and he got it.
To encourage your customers, especially your B2B customers to pay you faster, offer them discounts if they pay early.
If the invoice terms are 30 days after invoicing, you can offer 10% discount if the payment is made immediately. If it’s done within 3 weeks, the discount can be 7% and 5% if paid in the last week.
Any payment done after the due date can attract late fees.
Clearly indicate these terms on the invoice itself and don’t use the small fonts typically used for terms and conditions. It should be easy to see the offer since you’re trying to attract attention to them.
Communicate the same during contract signing and maybe even mention it when making a sale.
3. Pay Less Quickly
And just the same way you can encourage others to pay you quickly, you can also seek to pay others less quickly.
Before you label this as an unfair tactic, keep in mind that you’ll have to discuss this with your suppliers. They are the ones to either agree or disagree with your plan.
If they give you some extra room in payments, go ahead and take the longest time possible.
Since you’ll have it planned for, you shouldn’t get into any problems. And when the situation on your side is good, you can decide to surprise them one day with a prompt payment.
The best way to look at this situation is as a negotiation. You’ll be seeking to get the best terms through which to do business with your suppliers. And if they can offer it, why not?
Here is a video advising how to negotiate rates even if you already have an agreement.
Try it out and see. It works perfectly well.
You are looking to free up your money and you should look for ways to make that happen.
4. Sell Obsolete Assets
Cash flow is about in and outflow of cash, right? And positive cash flow is better than negative cash flow.
So what are you doing holding on to assets you no longer use yet they can bring in money?
If these are machinery or other physical items in your offices, save the space while making some money.
If it’s an old vehicle whose maintenance is high, why not sell it and get a new one on credit?
Do the math and see what the trade-off looks like.
But before concluding that a new one will be more expensive, consider the intangible costs involved.
For example, maintaining an old vehicle might be cheaper compared to buying a new one. But what is the impact of using that old vehicle?
Are deliveries often delayed due to slow speeds? Maybe due to frequent breakdowns? Or probably there is a lot of inefficiency since it can’t carry many products thus making more trips?
5. Use a Cash Flow Tool for Reporting
To see the cash flow status of your business, you require a cash flow summary. This can be provided by your accountant on paper or from the accounting system you’re using.
Find out from your team how much of an effort it is to generate the report. If you’re the one handling your finances, then how tasking is it to prepare a cash flow summary?
And do you do it correctly?
To get things running well and have the confidence that your data is accurate, consider using technology where necessary. Check out a few cash flow reporting tools and pick one if necessary.
Remember that you or your team also become more productive when your work gets easier.
6. Get External Financing for Big Purchases
When you’re about to make a big purchase, do not use cash for it.
What if the deal is a real bargain?
Even then, keep your cash away from the transaction.
Do you remember that one of the things you’ll be doing from now on is trying to get paid faster? How sure are you that the seller isn’t doing the same thing?
A rule of thumb regarding cash flow is this: always ensure you have as much cash as possible.
So whatever you do, seek to always have as much cash with you as possible. You never know what’s going to happen tomorrow, the next week, month etc.
And remember that cash flow problems have the ability to lead to business failure. Learn from those who went through the experience.
7. Leasing is Better than Buying
There has always been a debate on whether to lease equipment or buy them. Which side of the debate are you on?
Whereas it’s easy to see buying as the better option, believe it or not, leasing is actually better.
Because it’s cheaper.
Think about it. Between building an office block and renting a few offices in an already-built building, which is cheaper? Yes, other factors need to be considered, but in many cases, building your own office is more expensive.
When you lease equipment, you don’t own it. For that reason, the one who owns it is responsible for seeing it work as expected. That sets you free from the burden of maintenance and supply of necessary accessories.
For example, instead of buying a big 3-in-1 printer then maintain it yourself, you can lease one and save on maintenance. The only thing you’ll be doing is buying printing papers.
However, you still have to do your math to see the exact savings you’ll make before leasing.
For a printer for instance, check how many toners or cartridges you use per month.
If the cost of those toners is higher than the monthly payment you’ll make in the lease contract, then go for it.
8. Get Partial Payments for Big Orders
A common situation some manufacturers find themselves in is receiving a big order, starting to work on it, then get paid after delivery.
If you’re just starting out in business, you might agree to this arrangement for the sake of signing the deal.
But it’s dangerous. Do you remember that payments are rarely made on time?
To be safe, ask for some down payment or deposit of some sort. If the whole job costs $4,000, then ask for something like 25% of the full amount before beginning the work.
This way, even if there is some delay in payment, you have at least reduced the outstanding amount.
9. Have Some Cash Reserves
Even after all the planning and monitoring, rarely will everything go as planned.
As such, it’s wise to have some cash reserved for emergency cases. You can decide to make this amount a percentage, say 200% of your payables. This covers you for two months in case things get thick.
To be successful with this, you will do well to be clear what “emergency” means.
It should not be easy to get money from this account as that will not serve the intended purpose.
This money should only be used when nothing else can be done. It should be the very last option you have.
For example, you could decide that the money will only be used when your suppliers have threatened you with a lawsuit. Or when you’re almost about to be kicked out of your business premises.
Whatever situation you decide to use as a definition of your business emergency, just make sure it reflects the purpose.
Cash flow problems are real but can be avoided with proper planning.
Get to know your expenses, make projections and put a cash reserve in place.
This will help you mitigate any cash flow threats.