A Crash Course on Cash Flow Management

In 1993, the Wu Tang Clan made an eloquent statement about how success is measured with the track “C.R.E.A.M.” or “Cash rules everything around me”. It’s a statement small business owners should take to heart (if it helps you get in the right mindset, you can listen to the song here) especially in light of the fact that 82% of business failures are a result of poor cash flow management.

A positive cash flow—meaning that you have more cash coming into your business than going out of it—is essential for your bottom line. Without it, you won’t be able to do the essentials like pay employees, buy inventory, or cover operating expenses. To help you overcome the challenges of keeping tabs on your cash, we’ve put together a comprehensive guide that explains:

• What cash flow management is
• How it works
• Why it’s so important for your business
• What challenges small and medium businesses face when managing cash flow
• How to avoid issues with your cash flow

Let’s begin by exploring what cash flow management means.

Cash Flow Management Defined

Cash flow management isn’t as mysterious as it sounds; it’s simply the act of balancing business income against business expenses. The overall goal is to ensure a positive cash flow at all times while making the most strategic use possible of your cash assets.

Many small business owners confuse cash flow with profit, but it’s important to understand that these are two very different things. Cash flow is a fluid concept, referring to the movement of funds in and out of your business. Profit is what remains after expenses are deducted from your revenues. A business can be profitable but lack sufficient cash flow, which can threaten its long-term survival. This is why proper cash flow management is imperative to maintaining a sustainable operation.

How Cash Flow Management Works

Effective cash flow management begins with creating a cash flow statement. This is not to be confused with a balance sheet or income statement—both of which of measure different aspects of your business’s financial health.

Generally, it’s helpful to perform a cash flow analysis on a monthly basis. If you’ve been having issues with maintaining a positive cash flow, however, you may want to increase the frequency to weekly or even daily—at least until you have a better handle on where your cash is coming from and where it’s going.

To put together a cash flow statement, you’ll need to gather several key pieces of information, including:

• The amount of cash you currently have on hand
• An estimate of total cash receipts
• A list of your business’s operating expenses
• An estimate of the cost of goods sold
• Any other cash payments the business will make

To perform a cash flow analysis, add the amount of cash you have on hand to the amount of cash you expect to receive over the time period you’re running the analysis for. Again, this could be a day, a week or a month. Then, subtract your business’s expenses and cash payments from that number. The end result reflects your business’s cash position at the end of the reporting period. For additional tips on creating a cash flow statement, refer to our guide on cash flow analysis.

Once you’ve completed the initial cash flow analysis, the next step is creating a plan to managing your cash flow more effectively. For example, if you’re anticipating a shortfall, you could review your business budget to see if there are any expenses you could reduce or eliminate entirely.

You could also consider whether applying for a term loan to cover temporary cash flow gaps makes sense. Short term loans, for example, typically have repayment terms of less than 12 months and you may be able to borrow up to $1 million, depending on the lender. You just have to be mindful of how adding an additional debt payment to your monthly expenses could affect your cash flow over time.

Why Is Cash Flow Management Important?

Cash flow is a measure of the liquidity of your business assets. Regardless of how profitable the business is, you’ll find it hard to stay in the black if you don’t have cash on hand to pay your suppliers, cover your monthly rent or mortgage payments, or pay yourself and your employees.

A positive cash flow indicates that you’ve found an appropriate balance between the money your business is earning and what it’s spending. A negative cash flow, on the other hand, could suggest that your expenses are too high or that your customers aren’t paying their invoices in a timely manner. Being aware of your cash flow position can allow you to identify trends and potential trouble spots within your budget or business model.

Understanding cash flow and how to manage it is also vital for advancing your long-term business goals. Let’s say you own a small hardware store and you’ve been able to carve out a niche for yourself among the big-box competition. Your business is generating some impressive profits so you decide that it’s time to expand into a second location. To do so, however, you estimate that you’ll need at least $200,000 to lease a new space, purchase inventory and hire employees.

After evaluating your options, you determine that a term loan is the best way to realize your growth goals. You run a cash flow analysis to determine whether you can sustain the payments over the life of the repayment period. Because you’ve been diligent about managing your expenses and cash income, you know that the loan isn’t going to be a financial stressor and you’re able to move ahead with your plan to grow.

Common Cash Flow Challenges

Cash flow management sounds easy enough but for many small and medium-sized business owners, the path is often fraught with obstacles. For example, the act of creating a cash flow statement may be difficult if you haven’t been maintaining accurate financial records, or you use multiple accounts to receive income and pay expenses. When you’re trying to piece together data from different sources, it can be difficult to achieve a cohesive picture of your cash position.

Even when your accounts are relatively streamlined, you may still struggle with cash flow management if you don’t have a firm understanding of what your expenses are. The issue can be compounded when there’s no predictability in your accounts receivable. If you have some clients that are slower to pay than others, for example, that can throw off your estimates of your cash receipts for the month.

Sometimes difficulties with managing cash flow are the result of a miscommunication. Getting the due date wrong for a payment to one of your suppliers, for instance, could leave you scrambling to come up with the cash to pay. If you can’t pay on time, your relationship with the vendor could suffer, which could make it more difficult to run your business going forward.

Yet another challenge lies in finding ways to improve your cash flow. Increasing revenue or lowering your expenses are both straightforward solutions to a cash flow problem, but those aren’t things you can do overnight. In some cases, there may factors outside your control at work that prevent you from doing either.

For instance, if your sales have been on a decline because the economy’s hit a rough patch, your ability to cope with that in a positive way may be limited. The same may be true if you run a transportation-based business and gas prices are on the rise. Raising prices may help you to compensate for the increase in your expenses, but that may not have much of an impact on your cash flow if the ratio of cash in and cash out remains the same. If you have certain expenses that regularly fluctuate, you may not see the value of putting in the effort to try and trim those down.

Maintaining a Stable Cash Flow

Keeping your cash flow on an even keel requires a certain amount of work, but the payoff is well worth it. Implementing the following strategies can make cash flow management easier to tackle.

• Master your budget. A budget is an elemental tool for any small business and without one, it’s much more difficult to manage cash flow. Your budget allows you to define how you’ll allocate your business’s resources from month to month. Proper budgeting ensures that you’re not pushing your business into the red because of overspending.
• Learn to spot cash flow trends. The great thing about cash flow statements is that you can use them to gauge your cash flow position at any given time, based on your business’s historical performance. For example, if your cash flow significantly ebbs and flows at certain points during the year you can review your income and expenses to determine what’s causing those dramatic shifts and develop a plan for dealing with them.
• Evaluate your spending categories. Getting comfortable with budgeting is important because it makes it easier to scrutinize your spending more closely. Being able to group certain expenses together is helpful for understanding how those expenses are benefitting your business. If you see that a certain spending category isn’t creating any tangible advantage, you can move on to the next step.
• Reduce expenses where possible. If your cash flow statement shows a deficit, finding ways to plug spending leaks is a necessity. While some expenses, such as your rent or debt payments, may not be negotiable, you may find that you have some wiggle room in other areas. For instance, reducing your staff or your marketing budget may be an option if you’re coming off a seasonal sales rush.
• Monitor your pending invoices and payments. Knowing when you can expect money to flow into the business and in what amount can help you better estimate your cash flow position. At the same time, you should be mindful of when your expenses must be paid in order to ensure that there’s enough of an overlap so that nothing falls through the cracks. This is especially true if you have a particularly large invoice pending and a large payment coming up, such as taxes. You don’t want to run the risk of being short on cash in that scenario.

If you run into a glitch with your cash flow plan, seeking out small business financing can ease the pinch on your budget. Before considering a term loan, merchant cash advance or another borrowing avenue, be sure to evaluate the financing terms as well as the pros and cons so you fully understand what you’re taking on and how it could impact your future cash flow.

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