When you improve cash flow in your business is essential for the long-term success and stability of your company. Excess cash provides the fuel you need to develop new products, hire talented staff, expand your operation, and increase your marketing budget. And, a few simple changes might improve cash flow with very little capital expense; making this an attractive strategy for any business.
Maintaining a healthy cash flow is challenging for any business, especially in the early stages of a business or during economic downturns. As you can see from the image above, cash flow problems are among the top 5 reasons why small businesses fail in the US and you’ll find a similar pattern across the globe. However, by implementing a few key strategies, you can improve your cash flow and ensure your business has the financial resources it needs to thrive.
What is cash flow?
Cash flow is an accounting term reflecting the amount of cash on hand at any given time. Think about cash flow like your checking balance. Some days, money is deposited into your checking account from your paycheck or when a friend sends money to cover their share of a joint expense. This money increases the balance on your checking account. On other days, checks hit your account or you withdraw money using an ATM or debit card. These withdrawals decrease the balance on your checking account. Even though you might make enough money to pay your bills every month, if a check hits your checking account when there isn’t enough money to cover it, the check bounces and you incur a bank fee. More importantly, trust in you dwindles and that makes it harder for you to make future financial transactions such as rent a property, get a loan, or convince businesses to take your checks in the future. Because businesses don’t trust your financial well-being, they charge you higher interest plus those pesky bank fees grow over time. These costs represent a real cost to you.
Now, imagine the same situation happening to your business. You must pay a vendor but there isn’t enough money in your corporate account. Paying the vendor late often incurs a fee plus, over time, your vendor may choose to cancel your account or force you to pay for items up front. Over time, problems with vendors translate into problems meeting customer demands, which cost you customers. If you can’t pay workers, your best workers are the first to leave, which causes additional operational problems for your business. This becomes a vicious cycle of increased costs, problems meeting demand, and finally declining sales until your business is forced to fold. Such cash flow problems are a bigger source of business failure than almost anything else you can face as a business.
How to improve cash flow
You can improve cash flow by managing the influx and outflow of cash so you never face a situation where you don’t have the cash to pay for bills. To help manage cash flow, businesses commonly develop a set of pro forma financial statements. The first is a pro forma income statement based on anticipated sales volume and costs associated with running the business. Using realistic values is the key to building a successful statement. Most businesses start by forecasting sales based on one of the four tactics you can find here. Again, be realistic as this is no time for hoping.
Next, gather information about all the expenses you incurred over the prior period. If you’re a new business, this is harder but you should invest some time building a realistic list of expenses and gathering information from potential vendors. For instance, find a space similar to the type you need for office, storefront, and/or warehousing and collect rental information. Assess your costs for staffing using averages from one of the many online employment portals. Ask utility companies for average charges for similar businesses.
Once you have your pro forma income statement, break everything down by time periods to build a statement of cash flows. If you find a shortage at any point, arrange for coverage so you don’t find yourself scrambling at the last minute. Some businesses arrange for a line of credit they can draw from for just such occasions.
But, there’s more to improving your cash flow than simply knowing when you have surplus and deficiencies. You can improve cash flow through the policies you implement in your business. Here are five tips for improving your business cash flow:
Monitor and manage your expenses
By closely monitoring your expenses, you can identify areas where you can reduce costs. This might include negotiating better rates with suppliers, finding cheaper alternatives for goods or services you purchase, or cutting unnecessary expenses. A major way to reduce expenses is by leveraging your money. Leveraging refers to making your money work harder. For instance, if you rent equipment rather than buy it, you might save money, especially if you don’t use the equipment every day. The same goes for staffing. If you don’t need a full-time bookkeeper, outsourcing to a firm specializing in this activity means you gain access to folks with the right skills but only pay for the amount of time you need. With the growth of the gig economy, you can often find talented folks for almost any business task. By reducing your expenses, you can free up more cash that you can use to improve your business cash flow.
Of course, leveraging involves trade-offs. For instance, the hourly cost of outsourced staffing is more than hiring an employee but you don’t pay for 40 hours a week. Renting a piece of equipment you use frequently adds up over time so that it’s less expensive to buy it. There are financial algorithms to help you determine at what point it makes more sense to quit leveraging and take the plunge. These are called make versus buy decisions.
Invoice promptly and follow up on overdue payments
It is important to invoice your customers as soon as possible after you provide goods or services to them. To encourage prompt payment, many businesses offer other businesses a small discount, commonly 2%, if they pay their invoice within 10 days. To improve their own cash flow, many businesses make it a policy to pay promptly to get this discount. You should follow up with overdue payments in an attempt to collect them as quickly as possible.
Another option is called factoring. This involves selling your accounts receivable to a financial firm. The firm provides cash and charges a fee for making your money available sooner. Of course, you can’t factor accounts from businesses with poor payment profiles.
Offer flexible payment options and improve B2B turnover
Making it easy for your customers to pay you can help improve your cash flow. Consider offering a range of payment options, such as credit card payments or the ability to pay through an online portal. Additionally, consider improving business-to-business payments by implementing electronic invoicing and payment systems, which can speed up the payment process and reduce the risk of errors or miscommunications. This gives your customers more flexibility in how they pay you, which can encourage them to pay sooner. Additionally, improving business-to-business payments can help streamline your own internal processes and save time and resources.
Consider offering discounts for early payment
As mentioned earlier, offering a discount for early payment can encourage your customers to pay their invoices sooner and improve your cash flow. It is important to carefully plan for any discounts you offer, as you want to ensure that the discount does not waste your profits too much. Consider offering a small percentage discount for customers who pay their invoices within a certain timeframe, such as within ten days of the invoice date. You might also want to consider offering larger discounts for larger invoices or for customers who consistently pay their invoices on time.
Utilize short-term financing options
If you need access to additional cash to improve your business cash flow, consider using short-term financing options such as a business line of credit or a short-term loan. These options provide you with the financial flexibility you need to meet your short-term cash flow needs. Just be sure to carefully evaluate the terms and conditions of these financing options to ensure that they are a good fit for your business.
Improving your business cash flow is an ongoing process that requires careful planning and management. By following these tips and continuously monitoring your cash flow, you can ensure that your business has the financial resources it needs to succeed.
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