According to a popular U.S. Bank Study, 82% of small business failures are due to poor cash management. Small businesses are especially dependent on their cash flow, and must either cut costs or find alternative funding when they are not paid on time. Read on to learn a few cash management strategies that can help you avoid cash flow challenges.
What is Cash Flow?
Cash flow is the total amount of money being transferred into and out of a business. It is the lifeblood of all businesses. Small businesses are especially dependent on their cash flow and need to pay close attention to being cash flow positive – meaning, they need to make sure they have more money coming into the business than going out of the business. While this may sound like profitability, it is important to know that being profitable is not the same thing as being cash flow positive. For example, even if your financial statements indicate that you have invoiced or charged enough to cover the expenses needed to run your business, that does not mean the invoices will be paid or that the credit card funds will come in fast enough to cover the businesses recurring expenses. It is important to understand that many businesses have filed bankruptcy even though they have profitable financial statements.
Cash is King
Simply put, if you run out of cash, your business will fail. And, just because your accountant or accounting software indicates that your business is profitable, that does not mean you actually have the cash on hand to cover your recurring expenses. Some customers pay late…or not at all. In some instances, small businesses experience seasonal profitability where slow months tap cash reserves. In other scenarios, small businesses face cash flow challenges during times of rapid growth since they have to hire and pay their additional employees before their customers have paid them.
Often times, it is not a single incident that causes cash flow challenges. Usually, it is a combination of scenarios that causes a cash flow crunch. During these times, cash-strapped small businesses either find ways to cut costs or secure alternative funding to survive.
Exercising good cash management allows small businesses to make the investments they need to compete and pay less for money when they need to borrow.
Tips for Cash Management
Profitability is not the same as having cash in the bank. If you pay your bills, but your customers do not pay you, you can end up being cash strapped. It is important to keep cash reserves on hand to help you weather cash flow storms resulting from slow payers, seasonal slumps, and extra expenses that occur during times of rapid growth. As paradoxical as it seems, growth straps cash since you are often fronting the goods or services before receiving payment.
In most businesses, money is not received immediately for services rendered or products sold, so just because you have logged the sales, you cannot assume you have the cash needed to cover your expenses. When it comes to items like inventory, which is usually purchased and stored, the expense is incurred before the sale and cash is needed to procure the inventory. Cash flow isn’t intuitive and needs to be watched separately from profitability. Many accounting software programs offer cash flow management tools. For example, Score.org offers a complimentary cash flow template that can prove to be useful and mint.com provides active budget management tools.
Working capital is a measure of both a business’s efficiency and its short-term financial health. Working Capital = Current Assets – Current Liabilities. To sum it up, working capital is the money in the bank that you use to pay your running business expenses and buy inventory while waiting to get paid by your customers.
While working capital can help your business survive cash flow shortages, small businesses need to be responsible with their borrowing habits. You should only borrow money if (a) you know your return on capital will be higher than the cost; and/or (b) you have a plan in place to pay the loan or advance back without putting undue stress on your business. Read our post on Borrowing to Grow: Dissecting Myths and Realities for Small Businesses to learn more.
The early bird gets the worm. If you are watching your cash flow and can predict challenges due to rapid growth, seasonality, new opportunities, or slow payers, connect with a funder like Breakout Capital who can help you weather the cash flow storm. Businesses that prepare in advance for cash flow needs are generally rewarded with better rates and terms than businesses that wait until they are on the brink of failure.
Understanding what you need to know about various working capital solutions can be confusing. To help you navigate this process, we’ve laid out some key questions you should ask your prospective financing provider in Five Questions Every Small Business Should Ask When Obtaining a Loan or Cash Advance.
There are three vital accounting metrics to watch when minding your cash flow. The first is Collection Days, which is how long you wait to get paid. The second is Payment Days, which is how long you wait to pay your vendors. The last is Inventory Turnover, which is how long your inventory sits, which bogs down your cash flow. By keeping a running 12-month view on these key metrics, you’ll immediately have a better idea of your cash flow challenges and needs.
Be a Savvy Cash Flow Manager
Achieving positive cash flow happens with thoughtful planning. Businesses need to analyze and manage their cash flow monthly to effectively control the inflow and outflow of cash, and ensure they have enough cash to cover their obligations in the coming month. By proactively getting in front of future cash needs, small businesses can make the right business decisions to solidify their cash position, and establish a foundation for growth.
View our Financial Educational Series for a complete list of blogs dedicated to helping small businesses understand the nuances of keeping their business financially sound.
About Breakout Capital
Breakout Capital is committed to responsible funding. We believe it is better for you to keep your business and grow it responsibly than set it up to fail with insurmountable debt. Please contact us today if you’d like to partner with us.