For two such little words, cash flows play a major role in the survival of a business. So much so that, according to a US Bank study, a massive 82% of businesses fail due to cash flow problems. A common misconception is that cash flow issues are only related to a lack of money in a business’s account. In reality, the picture is bigger: late payments, poorly structured payment processes and a lack of organisation can be just as problematic as an empty bank account.
However, by investing some time in refining your invoicing procedures and doing a little bit of forecasting, you can do your best to minimise three of the most common threats to your company’s cash flow. Let’s go through some examples.
1. Late payments
The problem: If stressing out small business owners were a competition, late payments would take first prize. Perhaps the most frustrating cause of cash flow problems, late payments can jeopardise even the most careful budgeter. If the money you’re owed doesn’t hit your account before you have to pay bills and buy inventory, you could end up in serious trouble.
Let’s use our friend Bill as an example. Bill owns Ye Olde Firework Shoppe, a small fireworks business. November was a great month for him and he is owed $30,000 in invoices. Unfortunately, two of his biggest clients have missed their payment deadlines, leaving Bill short on cash to make the monthly payment for his warehouse space.
The solution: Firstly, make sure that your invoices are professional and your payment deadline is clear. Consider using an invoicing service like Invoice Home or Wave to create invoices and manage the payment process. Secondly, be firm on late paying businesses. Draw up terms & conditions before you start working together, and set up an automated follow-up process using email software like Boomerang.
Finally, make sure your payment process is as smooth as possible. Offer multiple payment options, like PayPal, credit card and bank transfer. If late payments are a really persistent problem for your business, consider offering clients an early payment discount.
2. No cash flow projection
The problem: As a small business owner, you need to have a firm grip on what’s coming in and what’s going out of your cash flow each month. Without a cash flow projection, you have no idea what figure to expect in your bank account. A cash flow projection can also help you to look at your business more holistically, preparing you for industry changes and seasonal variations, as well giving you an insight into customer satisfaction.
For example, Bill’s Ye Olde Firework Shoppe experiences seasonal fluctuations, with business peaking in October to January. However, his shop is open all year round, with associated fixed costs. Without a cash flow forecast, he can’t prepare as effectively for the quieter months.
The solution: Use last year’s sales figures to give yourself an idea of what to expect this year. Then calculate how much it costs to produce your goods or services – this will help you to adapt your projection if you land (or lose) a new contract or client. Factor in fixed overheads like rent, salaries, inventory and debt payments. No worries if you’re not a natural mathematician – there are lots of free cash flow calculators at your disposal, like Entrepreneur’s and Calc XML’s. (On a related note, you can find Spotcap’s really useful sales forecasting tool here.)
Use Excel to plot your projected cash flow month-by-month. This is especially useful for seasonal businesses. You may also find it useful to create multiple cash flow projections: an optimistic and pessimistic projection, as well as one between the two. As cash flow forecasts aren’t crystal balls, it’s important to keep abreast of macroeconomic and market changes that can affect your business’s performance.
3. Covering an unexpected expense
The problem: Unexpected expenses can totally throw even the most organised small business. From damaged property and repairs to tax bills and legal costs, it’s sometimes hard to find capital to cover the unexpected. It’s important to note that an unexpected expense isn’t a necessarily negative thing – it could be due to a sudden spike in customer demand.
For example, disaster struck at Bill’s Ye Olde Firework Shoppe. A rocket malfunctioned and exploded, shattering Bill’s windows and damaging his supply of sparklers. In order to stay in business, he has to make a vital repair to his shop and purchase more inventory.
The solution: Depending on what kind of expense you’re dealing with, there are a couple of options. The first is to get a small business loan. Offered by a range of traditional and non-traditional lenders, a business loan can allow you to make an up-front payment to a supplier while spreading the costs over forthcoming months. This can ease the strain on your cash flow if you don’t have the funds to immediately cover the expense.
If you need to purchase inventory, a solution like inventory finance may help. Furthermore, an equipment leasing arrangement can let your business acquire new machinery without large up-front costs.
So, to maintain a healthy cash flow, manage your payment process properly, draw up a cash flow projection and know your contingency plan if you come up against an unexpected expense. Of course, running a successful business isn’t an exact science, but keeping on top of your cash flow adversaries will put you in good stead for the future.
Originally published April 23 2018 , updated June 15 2018