People often say that cash is king when it comes to the management of any business, and it is true. More businesses fail due to poor cash flow than any other reason. Don’t just go by my word. A US bank study estimates that 82% of small businesses fail due to cash flow resulting in not having the money to pay business debts. Today, we’ll share 3 simple ways to improve cash flow so you have the money needed to support business growth, as well as for current monetary needs.
Cash flow management
Whether your company is thriving or struggling, it is important to handle your cash flow efficiently, and for most businesses, managing your cash flow can determine whether you succeed or fail. And, cash flow is never more critical than in the growth phase of your business when you need extra cash beyond just your normal expenses to fund hiring new staff, building new infrastructure, or adding new processes. The failure to have enough cash on hand at this time strangles your business; cutting off opportunities for growth.
It’s survival of the fittest in business as in biology and cash flow is the #1 reason why businesses fail. Surprisingly, many of the businesses that fail to turn a profit, simply run out of liquid cash needed for critical business functions such as paying employees, paying creditors, and keeping the lights on. These firms miss out on opportunities to grow and take advantage of other opportunities that might arise.
Maybe an example will help you understand why you need to improve cash flow to fuel your business.
Let’s say you run an e-commerce business. You need inventory if you want to keep cash flowing into the business. Poor cash flow may mean you can’t pay your suppliers, who cut off future inventory shipments so you can’t fill customer orders. Customers get pissed off and share their frustration across social media and in their physical communities. Soon, orders dry up and you have few options other than to close your electronic doors. If you don’t have enough cash to pay for mission-critical functions like inventory, electricity, and rent (or web hosting in an e-commerce business), you may have to close in as few as a few days.
You face a liquidity crisis when cash inflows (normally from customers) don’t match outflows for critical functions. You can borrow money in the short run to cover shortfalls but recognize that the interest demanded further straps your business and, in the long run, further exacerbates cash flow. The gap between the time you have to pay your suppliers and the time you collect money from your customers is commonly the problem, and better cash flow management is the solution.
Unexpected events can also arise with alarming frequency, such as the current pandemic that seemed to shut down the economies of most countries within a matter of days. Now, you owe money to a variety of folks, and, with your business closed due to the pandemic or sales drying up, you can’t pay the money owed to creditors and employees. In some countries, governments helped businesses survive the pandemic with things like payroll loans that became grants but you can’t always count on the government to bail you out when you run into a cash shortfall.
That’s why you must maintain a liquidity level that helps you make it through those tough times, allowing you to continue running your company. Simply put; managing cash flow means delaying cash spending as long as possible (reduce cash outflows) while encouraging your customers to pay their invoices as quickly as possible (increasing cash inflows).
Let’s take a look at how you can improve cash flow in your small business.
Improve cash flow in 3 easy steps
The first step to improve cash flow is to plan out where cash comes from and how much goes out at any given time. This plan is called a “statement of cash flows” and is a critical accounting document. Using historical information, as well as projections of sales and cash needs, the firm plans its day-to-day cash needs and then adjusts its spending to ensure it stays cash-positive every day.
While planning doesn’t improve cash flow directly, it helps firms manage their cash flow to avoid running into problems that might impede the operation, like those mentioned above. Armed with an accurate statement of cash flow, a firm can better plan and make decisions that avoid cash flow problems.
Get people to pay you
One of the easiest ways to improve cash flow is to get the people who owe you money to pay you as quickly as possible. For consumer-facing businesses, it’s customary to pay for items before purchasing them, whether online or in a brick-and-mortar store. Thus, this isn’t an option. For other businesses, owners commonly offer a discount for bills paid within 10 days while allowing up to 30 days for payment; so-called 2/10, n30 in accounting parlance.
To speed payment, bill customers as soon as possible and ensure invoices are as clear and detailed as possible to avoid disputes that slow down payments. Send invoices electronically to ensure they reach customers quickly. EDI (electronic data interchange) speeds payment processing through coordination across buyers and sellers, so that’s a great investment (below you can see how manual processing slows the payment process). Compare that with an automated system like EDI where the invoice goes immediately to accounts payable and the electronic payment goes directly into your corporate bank account once the company pays the invoice. EDI also reduces the possibility of redundant orders that must ultimately get eliminated or mistakes in entering an order that might result in more disputes and lower payments.
Consider sending invoices more frequently, for instance as each order ships rather than waiting until the end of the month to invoice customers. I once worked with a client that billed before shipment to ensure payment came in before the money needed to go out. To further automate the process you can use cloud-based invoice automation. So if your invoices are delivered through EDI, they are automatically analyzed and the most important information is recorded.
A payment tracking system, built into EDI solutions, helps you track who owes you what. Send reminders when invoices pass a certain age then continue sending reminders until the customer pays. Experience indicates that the less contact you have with a client, the less likely you are to get the money that they owe you, not without using a Skip Tracing service, anyway. Offer incentives to clients who pay in a timely manner, such as a discount on future purchases.
Look at short-term financing options
Establishing a line of credit with your bank is a great way to avoid cash flow problems. With a line of credit, you have cash to cover shortfalls and you pay the money back once you receive cash from customers. Another financing option, called factoring, allows you to sell your receivables (money owed on invoiced items) to a 3rd party at a discount. Both options improve cash flow and keep your business afloat.
However, both financing options increase your cost of doing business. So, good cash flow management helps you avoid paying these additional costs.
A better option is to set aside cash as a reserve for emergencies or unexpected expenses. Thus, instead of paying interest charges when you experience a shortfall, you earn interest on your reserve until you need it.
Effectively manage your assets?
Asset management is a great way to improve cash flow and software helps ensure you manage your assets efficiently.
For instance, rent equipment and facilities rather than buying them, at least in the short run as this avoids a high up-front cash outlay. Maintain owned equipment as recommended by the manufacturer to ensure you don’t lose productive time to break-downs and reduce costly repairs required when you delay maintenance. Sell unneeded or obsolete equipment to improve cash flow.
Plan effectively to ensure sufficient inventory on hand to handle customer needs without ordering excess inventory. Excess inventory involves a cost as it must be stored and insured against loss. As customer needs change, excessive inventory easily becomes outdated and useless. You must either heavily discount or pay to haul this outdated inventory away. This is especially true in markets where customer needs or technological changes require the development of new products.
If you engage in a manufacturing operation, Just in Time (JIT) is a way to better match your inventory of raw materials to your manufacturing needs. When you receive an order, the JIT system automatically schedules production of that order and ensures sufficient raw materials are on hand when needed by this schedule. If you need extra materials, the system orders them from your approved supplier list at the most favorable cost possible. If you don’t have enough material available, the system can also optimize production by rearranging the production schedule by delaying less time-critical manufacturing in favor of more time-critical orders. EDI, mentioned above, also should integrate with your JIT system to add further efficiencies in managing your cash.
Improve your sales and reduce expenses
These two processes should be part of your normal planning and require careful evaluation on an ongoing basis. Carefully consider your expenses with an eye toward ways to cut costs without impacting your operation. NEVER scale back on marketing activities as these hurt your operation in the long run. Instead, evaluate the performance of your marketing campaigns to reallocate funds from those with a lower ROI to those with a higher ROI. Thus, analytics is a core element of any effort to manage your cash more efficiently.
Improving your revenue is the key to running a successful business even when having enough cash on hand isn’t an issue. Increase conversion rates by removing roadblocks that cause consumers to abandon their shopping carts. Use tools like lead generation programs and remarketing to encourage consumers to finish their purchase, especially when conversion requires a sustained marketing effort, such as when selling high-priced products. Expand efforts to reach more of your target market by eliminating wasted efforts and improving messaging to emphasize how your product solves consumer problems better than your competition. Ensure high customer satisfaction by matching your promises to your delivery and optimizing your customer service operation. Tools like chatbots allow you to offer 24/7 customer service when properly trained.
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