Cash Flow
Dear Readers,
Managing cash flow is arguably the most important aspect of one’s business. And we’ve all probably heard the statistic that over 60 percent of businesses that fail are still profitable, but lacked enough cash at the right time. Small businesses often say that an inability to control cash is their single biggest problem. Darlene, a seasonal business owner of five years struggles with having the right amount of cash on-hand. She asked, “how can I better manage my cash flow?”
Pedro: Indeed, making a profit is nice, but cash flow is absolutely critical.
Josh: Yes. Perhaps there is some truth to the adage, “cash is king.” Existing businesses can find ways to survive if they can find ways to generate cash. Cash is the single most important element of survival for a small business.
Pedro: That makes sense. Just like an individual or a family, companies need a cash cushion to rely on. This gives them security in unstable times. It also provides them an opportunity to take advantage of strategic investments or take advantage of opportunities to reduce costs. So why do so many businesses fail due to cash flow rather than lack of sales?
Josh: Well, first - cash flow and profit are not the same. Cash flow refers to the amount of funds coming in (sales) and going out (expenses) of your business and the timing of those flows in and out. Accounting is not focused on cash flow; accounting is focused on profit. Over the long term, profit and cash flow are approximately the same, but the crucial difference is timing. Businesses can find themselves with a timing gap between profit and cash flow. For instance, if you have rapid growth in credit sales, your profit could far exceed the actual cash received. This sort of situation makes smaller companies very vulnerable to running out of cash.
Pedro: So do you have any tips for how a business can avoid running out of cash?
Josh: Well, I suppose there are no guarantees, but here are a few tips.
1. Bill early and bill often. You can increase your cash flow by invoicing more frequently. Often, businesses get into the habit of only invoicing once a month. While this may reduce the internal workload of your staff, it can really slow down your cash flow – and thereby impact your liquidity.
2. Offer discounts to your clients if they pay quickly. If you’re working to improve your cash flow, then give your clients a reason to pay early. A discount of 2 to 3 percent isn’t a lot to give up when you need to improve your cash flow.
3. Negotiate terms with your vendors that are more favorable to your cash flow. Most companies work on a 30-day payment schedule. However, if you’re in an industry that has slow paying clients, or in a seasonal business like Darlene, then it’s maybe appropriate to negotiate 45- or even 60-day terms with your vendors. But to do this, you have to know your own cycle: when do you have to pay your vendors; when are your bills due? Don’t make the mistake of granting your customers easy terms just to make the sale when you don’t have the same luxury with your suppliers. Asking for more money up front is another way to reduce risk to your cash flow.
4. Set up smarter payments. Online and mobile banking capabilities can help you avoid incurring late fees and penalties. Control cash flow with online direct payments so that individuals or businesses get paid on time. Making payments electronically also enables you to hold on to your money longer, since you decide when the funds will be taken from your account: If a bill is due in 30 days, don’t pay it in 15. Schedule to pay it on the day it’s due. You’ll remain current with your vendors and you’ll also hold on to your cash longer. When it comes to optimizing your accounts receivable, it’s a good idea to make use of cash flow management tools offered by banks like remote deposit capture, which lets you avoid the hassle of taking checks to the bank and offers the convenience of later deposit cutoff times. Using a bank-provided scanner, you can make unlimited deposits to your business checking account from your office or home.
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