For growing companies, cash is king. For entrepreneurs and small business owners, cash flow can be a defining factor for whether or not your business succeeds. So how do you improve cash flow?
Put simply, business cash flow is the balance between the cash flowing into your business and the cash flowing out of it. Small business growth requires increasing investments in staff, administration, equipment, and materials. Without the cash flow to cover these expenses, you can quickly get in over your head.
Diagnosing the state of your small business cash flow is fairly straightforward. If you have more cash outflow than inflow, you have a cash flow problem. If you have more inflow than outflow, you’re in a great position. So, how can you ensure a positive cash flow that grows as your business grows?
Here are some basic do’s and don’ts that will help you improve your business cash flow:
Do: Collect up front and pay later
Cash flow is like a game of tug of war. You want to collect as quickly as you can. Your suppliers, meanwhile, want you to pay as quickly as possible, and usually in advance. Your job is to collect sooner and pay later. Collect deposits at the start of work and create package pricing that ensures you get paid before the full delivery of service. At the same time, ask your suppliers if you can extend terms without paying interest and they just might say yes. If you can pull this off, you will improve your cash flow.
Don’t: Use a factoring service or advance service to cover expenses
Some services will advance you funds in exchange for a fee, and request these funds be paid back within a few months. This is cheating. Funding services are a Band-Aid solution to a shortage of cash flow, and as cash flow is the life blood of your business, that shortage is a sign that there is a fundamental problem in your company that needs to be addressed. Use these services sparingly (and only when necessary) as a temporary solution, but do not rely on them to improve cash flow.
Do: Reduce your inventory
If you sell products, bear in mind that larger inventories require more cash to maintain. The simplest fix here is to look for ways to reduce your inventory. Perhaps you could implement a Just In Time (JIT) inventory system that enables you to order and receive goods only as needed. As your business grows, you can ask for better terms from your suppliers that will allow you to expand your inventory.
Do: Reduce your Work in Progress
If you sell services, you need to reduce your overhead production costs, often referred to as Work in Progress or Work in Process (WIP). For example, when you pay employees to provide a service, that outlay of cash comes in advance of receiving payment from your client, which usually arrives 30-40 days after delivery of the service. This puts tremendous strain on your cash flow. You can reduce this by invoicing more frequently or asking for a deposit. The best solution is to stop charging hourly and start offering value-priced packages that are the same every month and collected up front.
Do: Use credit cards (… and pay on time)
All credit cards have grace period of 21 or 28 days. This is essentially an interest free loan that you can take advantage of every month to improve cash flow. Many credit cards also have fringe benefits, such as points earnings or cash back. That said, you MUST pay your credit cards off on time, because paying 29.99% interest on late payments is the exact opposite of improving cash flow. Assuming you can manage this, using credit cards is ideal from a bookkeeping standpoint because your credit card transaction records offer a detailed paper trail of your business expenses. Here’s more on setting up a simple bookkeeping system.
Don’t: Continually use a line of credit
A line of credit is essentially a revolving loan. The idea is that you use them and then pay them back within 30-60 days, at which point those funds become available to you again (hence the revolving part). This makes lines of credit rather dangerous, because having one is like having a really, really, large credit card allowance. The initial interest rate is often much lower than your credit card, so comparatively it seems like a great option. However, most people treat lines of credit as a standard loan, and rarely pay them back within the time allotted, resulting in high interest charges. A line of credit should only be used in times of emergency. As mentioned above, what you should be doing is examining your business and see if there are fundamental problems to your cash flow. A line of credit is a Baid-Aid, not a solution to cash flow.
Do: Reduce expenses
Every company has recurring subscriptions to things that they never use. For example, let’s say you use a SaaS CRM and pay per person per month, but someone has just left your company. That extra $20 a month that you’re paying will add up over the year. Review your credit card statement, bank statement, and financials to identify unused subscriptions. Take a hard look at meals, entertainment, and any other luxuries that could be cut down, and evaluate campaigns (ex: Google AdWords) to determine their effectiveness. If something is unnecessary or unproductive, cut it. Cutting costs is the most sustainable way to improve cash flow.
Don’t: Short change your employees
When cash flow gets tight, some business owners are tempted to short pay their employees or to delay paychecks. This is dangerous territory. Your employees are your company’s most important asset, so it’s not wise to extend terms with them. If you have a great relationship with your team, they may be understanding of the circumstances and accept delays for a short time. But, at the end of the day, they need to make a living. If they leave, they take vital expertise with them, which will only worsen your already tight predicament. And if they leave with a bad impression of you and your business, it could seriously impact your reputation in the community.
Let me repeat again
Revenue is Vanity, Profit is Sanity, Cash is King
Don’t just chase revenue, but make sure you’re also profitable. And at the end of the day, make sure you have more cash in your hands than the day before.
If you’re interested in how a great bookkeeper can support you to improve cash flow, click here.