Cash Flow Management for Small Businesses: How to Keep Your Business Afloat + Template
Cash flow management is a crucial aspect of running a small business. It refers to the process of monitoring, analysing, and optimising cash inflows and outflows. In other words, it’s about making sure that the business has enough cash on hand to cover its expenses.
According to a recent study by US Bank, 82% of small businesses that fail do so because of cash flow problems. A common issue for small businesses is that they may not have a steady stream of revenue or sufficient capital to manage their expenses. This can result in a situation where the business is unable to pay its bills, which can lead to debt, late fees, and even bankruptcy.
In this article, we’ll go in-depth into the meaning of cash flow, provide tips and advice on how to effectively manage cash flow, avoid cash flow problems, and ensure that the business has enough cash to cover expenses.
Defining Cash Flow
Let’s say you own a small bakery. You sell cakes, bread, and pastries to your customers. You buy flour, sugar, and other ingredients to make your baked goods. You also pay rent for your storefront, utilities, and employee salaries. Cash flow is the movement of money in and out of your business. In this scenario, cash inflows are the money you receive from selling your baked goods to customers. Cash outflows are the money you spend on ingredients, rent, utilities, and salaries.
When you have more money coming in than going out, your business has positive cash flow. On the other hand, if you have more money going out than coming in, your business has negative cash flow. It’s important to track your cash inflows and outflows to ensure that your business is profitable and sustainable over the long term. It is also essential to recognise that positive cash flow does not always equal profit. For example, a business may earn a 30% profit on every product sold but still have negative cash flow due to more expenses than income.
Small business owners must differentiate between accounts receivable and accounts payable. Accounts receivable is an asset account that tracks money coming into the business from customers for goods and services provided. In contrast, accounts payable is a liability account that tracks money leaving the business, including expenses like employee payroll and bank loans. To determine the profitability of a business, add up all assets, including accounts receivable, and subtract the total accounts payable. If the result is positive, the business is profitable, but if it is negative, owners should look for ways to increase profitability.
Importance of Cash Flow Management for Small Businesses
Cash flow is the lifeblood of any small business. Positive cash flow helps a business grow, while slow or negative cash flow can lead to issues. In the early days of a business, owners may need to invest money and see more money leave the business than come in. However, as the business grows, these cash flow problems may become less severe.
On the other hand, poor cash flow management can lead to various negative outcomes that can impact the overall health and stability of a business. Businesses with poor cash flow management may find themselves unable to take advantage of new opportunities that require upfront capital investments. This can include new marketing campaigns, hiring new staff, or expanding into new markets.
Furthermore, poor cash flow can lead to a lack of financial stability and flexibility, making it difficult for businesses to weather unexpected costs or economic downturns. This can include everything from unexpected equipment failure to a sudden drop in demand for products or services.
Finally, poor cash flow management can impact the morale of employees, who may feel insecure about the financial stability of the business and may be more likely to leave for other opportunities.
Tips for Effective Cash Flow Management
Here are some tips that can help you manage your cash flow effectively and ensure that your business has enough cash to cover expenses:
Keep track of your cash flow by creating a Cash Flow Statement
We have created a simple Cash Flow Statement template you can use to track your monthly cashflow by filling in each income source and expense source. For this, be sure to be as detailed and as broad as possible. You can download the template for free here.
Categorising all transactions and reviewing your statements regularly helps you identify areas where you can cut costs. For instance, if you notice you’re spending a lot on marketing, you may want to evaluate which marketing channels are producing the most ROI. As depicted above, a Cash Flow Statement is generally divided into three sections:
- cash from operations
- cash from financing, and
- cash from investments.
Create a cash flow forecast
Use your historical data and projections to predict future cash flow. For example, if you own a seasonal business like a landscaping company, you’ll likely have more revenue in the spring and summer months. Plan accordingly and adjust your expenses during the slower months.
Consider Financing Options
As a small business, you may need to invest your own money or explore financing options, such as business loans, lines of credit, or small business grants, to cover startup costs.
Cut unnecessary expenses
Look for areas where you can reduce costs, such as subscriptions or rent. If you’re renting office space, consider downsizing or negotiating a lower rent. If you have subscriptions to services that you no longer use, cancel them. These small adjustments can add up and improve your bottom line.
Send out invoices as soon as possible and follow up on late payments. You can use online invoicing software to automate this process and save time. For instance, if you’re a freelancer, consider using tools like FreshBooks or Harvest to send out invoices with a click of a button.
Offer discounts for early payment
Consider offering a discount to customers who pay early to encourage timely payments. For instance, if you own a retail store, offer a small discount to customers who pay in full at the time of purchase.
Keep an emergency fund
Set aside some money for emergencies, such as unexpected expenses or a dip in revenue. A good rule of thumb is to have at least 3-6 months of expenses saved up. This will give you a cushion to fall back on during tough times.
Effective cash flow management is crucial for small businesses. By understanding your cash flow, predicting future cash flow, and taking steps to ensure positive cash flow, you can keep your business afloat and avoid financial problems. Use the tips in this article to manage your cash flow effectively and set your business up for success.
Download the free Cashflow statement here