Small business owners have a lot of demands placed upon them as they grow their businesses. One of the most essential responsibilities is to protect cash flow at all times. We all generally understand the concept of cash — after all, it implies the presence of tangible, physical dollar bills that we can hold onto. But the concept of flow is much harder to grasp. How does cash flow, exactly? And what causes the flow to increase and then ebb?
Understanding the Role of Cash Flow
The cash flow of a business is the stream of revenue and expenses that cause changes to the company’s cash account over a given period of time. The cash inflow comes as a result, in most cases, of three drivers: revenue from operations; funds generated through debt financing; or money received from equity investors. The cash outflow is a result of production or operating expenses, as well as investments or debt service.
Where cash flow becomes dangerous is in the flow itself, especially conflicts in the flow between cash received and cash disbursed. The goal of effective cash flow management is simply to ensure that the company never finds itself short of cash at any point or during any period. This has nothing to do with profitability, nothing to do with sales booked, nothing even to do with cash in the bank at this moment.
Rather, cash flow management is about understanding and managing the scheduled and unscheduled inflows and outflows of cash so that it is always within safe range of predictability and manageability.
Many a business has won a large contract, taken out a loan to pay for capital or personnel to service the contract, then found itself cash flow-negative as a result of slow payments or contractual delays. The result in a situation such as this could be disaster.
Here are five areas in which you as a small business owner can almost undoubtedly tighten and improve your cash flow management:
1. Product or Service Pricing
Many small businesses keep their prices low to maintain a competitive market position and placate current customers. However, the first and foremost way to improve cash flow is to increase revenues. In addition, it’s essential to keep in mind that in addition to cash flow impact, weak pricing can result in little to no profit margin.
Don’t be fooled, a business can actually be losing money and survive for some time without realizing it. Take the time now to analyze your accounts, your costs and your pricing to determine where and how you can and should increase prices to protect both profit margins and cash flow.
What is the point of raising prices (or even keeping prices flat) if you don’t demand payment? Small business owners are legendary for falling into the late payment acceptance trap. Sure, a longtime account might have earned enough trust to pay their bill on slightly delayed terms (in which case, don’t accept it as late — change the customer’s official payment terms to match the agreed-upon adjustment).
Collection does not have to be stressful, in fact the more proactive you are the less stressful it will be (for you, and for your customers). Everyone needs a reminder, now and again. And the longer an account falls into arrears, the harder it will be to correct and the more defensive the client will be when you finally do confront it.
3. Debt Load
This is the factor that famously took down a number of President Trump’s less-than-successful empires (such as the Trump Shuttle airline and multiple Atlantic City casinos). Yes, he brags about it today, but his personal house wasn’t on the line and he didn’t have to risk declaring personal bankruptcy. You probably are in a different situation.
Debt is a wonderful and powerful tool for growing a business. Some business owners are naturally debt-averse, and that’s certainly admirable in the philosophical sense, but in reality debt is a critical tool in the growth toolbox. The problem is not debt, it’s the addiction to debt and the risk to cash flow that comes as a result. Make sure you carefully plan for the cash flow impacts of any new debt you accept, because those payments can add up (especially if they are variable and can go up at a later date or adjust as interest rates rise).
Another place to look as you seek to free up cash flow and increase operating flexibility is in managing overhead. Do you need all of the office space you currently rent, or could you sublease some of it? Maybe you can switch from an expensive office supplies distributor to a lower-priced provider or a warehouse club. That expensive copier lease could probably be dispensed with, and there’s nothing wrong with shopping for office furniture at Ikea instead of Steelcase or Herman Miller.
5. Supplier Terms
Your suppliers depend upon your business for their business, and they deserve respect. Do pay them on time, every time. But that doesn’t mean you have to leave it at that. Remember, it never hurts to ask for changes that would benefit you without unduly damaging them.
This could include delayed payments at the start of the month (have them charge you on the 3rd or the 5th, perhaps); splitting payments up to reduce cash flow impacts; reducing prices or fees as a courtesy; or asking for a 5% discount for paying bills early (as opposed to on time). All of these adjustments together can really add up to significant benefits for your business, all without causing trouble for your suppliers.
Cash flow is truly the lifeblood of your small business, and ignoring its ebbs and flows is a risk not worth taking. Take the time now to meet with your business accountant and review the key elements of your cash flow strategy today so that you can take better control of what lies ahead and strengthen your business for the future.