How to Manage Your Cash Flow (and Keep Your Business Afloat)

By Jennifer Craig | June 15, 2011

Money, or the lack of it, seems to be the main issue that constantly confronts small businesses. Whether the business is just starting or has been in business for awhile, they all need operating cash flow. Simply said, businesses need available cash to pay monthly bills, unforeseen expenses and for operations (keeping it afloat). Without cash flow, business owners could easily be out of business within a short time.

How do small businesses get and manage cash?

Startups must have enough money to open and run their business while waiting to make a profit. During the planning phase, they should have been thorough in estimating dollar amounts because it is a given that they will either have their own money to invest into the project or they will need to borrow it. If they have planned carefully, they know exactly how much is needed to open and operate the business. If they haven’t planned well, this could be a place where major mistakes happen. To better understand what is needed, entrepreneurs should make a thorough list on how they will be spending their cash:

  • Deposits (rent, utilities, telephone)
  • Licenses
  • Insurance (liability, theft and fire, and workers compensation)
  • Signage and advertising (includes brochures and business cards)
  • Business supplies (paper products, ink, etc.)
  • Merchandise (products to resale)
  • Equipment, fixtures, lighting, furniture
  • Payroll, benefits, payroll taxes (that will need to be paid)
  • Shipping, postage, packaging
  • Accounting/legal issues (incorporating, leases, contracts)
  • Miscellaneous (software, tradeshows, travel, etc.)

The worst scenario is to borrow money, spend it on startup expenses and find that something of importance (usually costly) has been forgotten. When that happens, the business starts out behind automatically and it will be difficult to catch up – not to mention costly in trying to come up with additional monies to cover the expense.

How do existing businesses manage cash flow?

Cash flow management (avoiding cash-flow gaps between the incoming and outgoing cash) is something that plagues a business owner throughout the life of the business. Sometimes that task is not easy, especially if they are growing rapidly, have unpaid accounts receivable, have a decrease in sales (due to economy, competition, or other factors), have experienced an unexpected expense like equipment repair or replacement, and a number of other variables that can impact cash flow.

Business owners often feel that it is a balancing act to keep enough money flowing through the business while still meeting goals and objectives, growing, hiring and terminating employees, and paying taxes.

What is Cash Flow?

A good analogy for cash flow is a checking account. The cash at the beginning of the month is “cash on hand.” Deposits are made and checks are written. In essence, the cash is flowing (coming in and going out). The money left at the end of the month is carried to the beginning of the month and the process starts again. What happens if the money that flows out of that account doesn’t match the money flowing into it? The answer is that a gap occurs which has to be closed in order to keep the account in the “black” or to avoid “negative” cash flow (more cash going out than coming in). For the sake of the business, it is best to maintain “positive” cash flow (more cash coming in than going out), which also prevents an array of problems that eventually may shut down the business.

Managing cash is a challenge all businesses face simply because they are paying suppliers, landlords, employees, utilities, or other expenses faster than sales are being made. Cash is the money available (on hand) and if it isn’t there, expenses cannot be met.

A retail business once told me they didn’t need cash flow because they were not planning to give cash back to customers who returned items. Instead, the customer would have to exchange for merchandise or a credit. That particular business was putting every bit of extra cash into its inventory and couldn’t see that a huge problem was waiting just around the corner. Inventory is not cash.

Likewise, a service business called desperately needing a loan. In discussing the problems with the owner, I learned that sales were soaring. In fact, the business had increased sales by 200 percent that month alone. So where was the cash going? Well, the owner said, they had to increase staff, gasoline expenses were rising, and new equipment and supplies were added. Further investigation revealed that the owner, who had been receiving payments for services at net-30, was now carrying some accounts for 60 and even 90 days. These were large national accounts and it was taking time for them to add the small business into their system. Eventually those accounts would be on net-30 (meaning, that once billed, they would pay within 30 days), but at that time, the lack of cash was putting the business in a bind. Accounts receivable is not cash.

Can a business be profitable if it doesn’t have cash flow?

Absolutely! However, a business cannot spend profit. It needs cash! If a business has its money tied up in too much inventory or uncollected receivables, it can be profitable but have no cash flow. A quick solution would be to turn inventory over quickly and pound on a few doors to get paid on outstanding accounts. Realistically, that isn’t always possible, making it very important for the business to manage the cash flow on a daily basis.

In essence, managing cash flow requires analyzing the business, developing strategies to maintain adequate cash flow, and forecasting potential problems that might hinder cash from flowing.

What tools are available to better manage money?

Historical cash flow reports along with short- and long-term cash flow projections are excellent tools. Think of looking into a crystal ball at the future of the business. Those projections (referred to as Pro Forma by bankers) can create a more accurate picture of the business for the future, even six months down the road. Based on existing information, the business can estimate what it will cost to keep the business operating. Knowing what has happened in past years and what is going on with the business at the present time, make the projections more accurate.

Developing strategies is a smart way to manage cash flow. Small businesses need to remember that just because cash is flowing in the business doesn’t mean the business is profitable. Let’s say, the business has just sold out some old equipment, sold property, or liquidated other assets. It is experiencing a “positive” cash flow; but sales are really down and expenses are rising. Is that profitable? No.

Understanding that cash flow helps the business answer questions as to whether it needs to save for a piece of equipment, take out a loan for an upcoming project, save a percentage from the “high” season to help pay expenses during the “slow” season, or to know when its owner can receive an increase in income.

If a business carries accounts receivable, a cash flow projection can show how important it is to collect those receivables on a timely basis. These are all business management issues that can be addressed and answered with a thorough understanding of cash flow.

The bottom line, then, is to stay on top of the business by creating and reading accurate reports on the business’s activities: like the Balance Sheet, Cash Flow statement, and Income and Expense (Profit/Loss) statement. Watch inventory and accounts receivable, but above all, keep that cash flowing in a “positive” way.

Download our free interactive Financial Statements worksheet to help you better manage your cash flow.

About the Author

Jennifer Craig

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