Is your cash flow killing your business? A guide on how to fix it

Blog, 02/02/18 Image

One of the most common mistakes among new business owners is to not take cash flow seriously. No, cash flow is not just calculating the difference between your revenue and your costs – that’s too simplistic.

You want to understand what’s taking up your costs and you want to understand what’s making you money.

Having a very general overview of your cash flow instead of a detailed breakdown is going to cause a lot of issues in the management of your assets.

What did I spend $5,000 on last month?

Where did this $250 come from?

How the heck did I spend $3,000 last week?!

These are all questions that are easily answered if you have a proper cash flow management system for your business.

In this post, we’re going to talk about what cash flow is, how it’s going to kill your business if you don’t manage it, as well as tips and strategies on how to optimise your cash flow – in other words, make more money than losing it.

What is cash flow?

Usually, cash flow is referred to the money that is moving in and out of your business for a particular month. The term cash flowcomes from this process where money flows in or out of your business.

Before we move on to discussing cash flow, here are some accounting terms that you need to familiarise yourself with. Even if you have a dedicated accounting team, you still need to understand the basics of running a business.

  • Accounts receivable. Money that is owed to you by your customers or clients
  • Accounts payable. Money that you owe others e.g bank loans, business loans, or your office rent

Now, what are the aspects that make up a cash flow statement?

  • The first aspect of a cash flow statement is money coming into the business. This money can come in from clients or customers who purchase your products and services. If a customer does not pay at the time of purchase (e.g NET30 invoices) your positive cash flow comes from your accounts receivable.
  • The next thing is to calculate the amount of cash going out of the business. This may be for expenses such as your employees’ salary, the office rent, or monthly loan payments. You also have to consider the accounts receivable portion of your business as money going out of the business.

It is helpful to think of cash flow as a reflection of your checking account. You are in a positive cash flow when more money is coming in than out. This is the point where your business is considered as profitable.

However, you may also be in a situation where more money is going out than coming in which leads to a negative cash flow. In most cases, you will be in an overdrawn situation where you withdraw money in excess of what your bank account holds.

This is the number 1 reason why small businesses need capital. Whether it is a business loan, a line of credit, or emergency savings, a capital is needed to cover negatives in the business’ cash flow when there is no money coming in.

You are not the only one who’s facing cash flow issues; even profitable businesses can fail if cash flow is not managed properly. If you don’t have enough money to pay your suppliers or creditors, banks can and will foreclose your account while suppliers could cut your supply immediately.

There are many areas in your business that can impact on your cash flow. It is important to understand how customer payment terms, supplier payment terms, loan payments, future spending decisions and other items can affect your cash flow.

Why is cash flow so important?

Managing your cash flow is as important as fuel for your car (let’s assume that you don’t have a Tesla, alright?) Without fuel, your car will fail and the same thing happens to your business.

For this section, we are going to highlight the importance of cash flow by telling you what can happen if you have a negative cash flow.

For your business to remain viable and secure, you MUST ensure that there is always sufficient funds to meet the financial obligations of your business. For instance, the obligations could be your employee’s payroll; it could even be the monthly CRM fee.

The problem with cash flows is that money that is coming into the business does not always come at the right time; it could come at a time when your debts are already due for payment.

If you cannot settle these payments as well as meeting your financial obligations, your business will be deemed insolvent which means that you do not have enough cash in the bank.

Remember what we said earlier, a profitable business can have a negative cash flow.

When this situation occurs where financial obligations are not met, the following can happen which will eventually lead to some sort of failure in the business.

  • National law and regulations – Depending on your country, there might be corporate laws that prevent you from running your business if you have no cash flow (insolvent). For instance, in Australia, your business does not have to be profitable but it is illegal to continue trading if you have zero cash flow.
  • Paying your loans -If you don’t have enough cash flow to repay your loans, your loan will be defaulted which would trigger several legal actions against your business. This ends in bankruptcy for most cases.
  • Paying your staff – Having not enough money to pay your staff is a terrible feeling. It sucks even more if you lose your best employee along the way. A lack of funds paired with a lack of key staff will rapidly bring down your business.
  • Poor decision making – As humans, we tend to make poor decisions when we are desperate. There’s nothing worse than having negative cash flow which severely affects your mood and thoughts. Poor decision making in the short-term can affect your business negatively especially if the decisions are related to the core model of the business.

To save the business from the potential negative impacts listed above, it is incredibly important for your business to manage its cash flow to ensure that you have sufficient cash at all times to meet the financial obligations as they become due.

Now, let’s look at the positive side. What are the advantages of having proper cash flow management?

Instant liquidity

With a positive cash flow, you have a lot of liquidity on your hands to run the business. Increased liquidity means that you’ll have more money to reinvest in your business which accelerates growth.

Reinvesting gives you more opportunities to add valuable staff members, expand your assets (a bigger office, for example), as well as investing in new processes to help your business become more productive, profitable and competitive.

More cash on hand also allows you to gradually pay your debt which reduces your monthly financial commitments. Business killers such as high-interest rates and late-payment fees are a thing of the past with proper cash flow management.

Increased productivity

When your cash flow is under control, you will spend less time and worry less about managing your business finances. Keeping track of your accounts receivable, accounts payable, and deposits are things that you don’t really have to lose sleep about when you have money.

This can free up time to allow you to spend time on growing the business, communicating with your clients, and seeking new business opportunities.

Less stress

Meeting the needs of your clients and employees is stressful enough. You don’t really want the added stress of not having enough money, do you?

Knowing that you have available cash on hand gives you the peace of mind to know your business finances are ready for whatever opportunities or challenges that lie ahead.

Cash flow analysis

For businesses without an in-house accounting department, performing a cash flow analysis regularly is the most important thing to do for your cash flow. You don’t want to run out of cash as a business owner; an analysis allows you to do just that.

Regular analysis of your cash flow helps you to avoid a negative cash flow as well as managing your running costs more efficiently. You’ll also be able to understand the dynamics of money flowing in and out of your business clearly.

You perform a cash flow analysis using a cash flow statement. A cash flow statement is a spreadsheet or statement that records how much money flows into and out of your business for a period of time.

Understanding the purpose and importance of a cash flow analysis

A cash flow analysis gives you a detailed breakdown and overview of your business’s financial status. For example, you’d have a planned budget to spend on groceries or what not; the same principle should also be applied to your business finances.

Regularly analysing your business cash flow will tell you whether you’ll be able to pay your staff, expand the office, buy new equipment, and other financial activities.

If your cash flow analysis shows you’re running short of cash to meet expenses, you can plan ways to cut costs, obtain short-term financing, or take steps to accelerate income.

If your cash flow analysis shows you have extra cash on hand, consider whether to invest it in the business or save for rainy day funds.

Keep in mind that having a lot of cash on hand doesn’t necessarily mean your business is profitable—that’s determined by your profit margins. Conversely, even a business with strong profit margins can get into financial trouble if it doesn’t have the cash on hand to pay the bills.

And a business that has a lot of debt at one point in time can still be financially strong as long as the owner knows projected cash flow can be relied on to cover the debts.

What are the advantages of cash flow analysis?

Cash can be measured and compared

Cash is tangible and is a medium that is accepted by everyone. Even if two companies have completely different business models, cash is still the asset to compare its growth and profitability.

You can’t fake cash

There are techniques and gimmicks that you can use to artificially inflate your profits to project the image of a successful business. It’s difficult to do that with a cash flow analysis.

It’s universally accepted as a store of value

You don’t have to convince anyone about the value of $10 million in cash. The same cannot be said for other assets like intellectual property, goodwill, office equipment and more.

A used forklift may be worth something to the owner of a warehouse but it’s worthless to a writer. An idea may be valuable to some people and useless to others.

Everyone accepts cash.

How to perform a cash flow analysis

A rule of thumb to remember about performing cash flow analysis is to do it once a month. Doing it daily or weekly is not a bad idea either especially if you are in a highly volatile industry.

For performing the statement itself, you can do it with a spreadsheet like Excel or do it in your favourite accounting software. If you are a non-tech guy (which you should be in 2017), you can do it with a pen and paper.

1) Start creating a cash flow statement and an opening balance

Initially, calculate your business’ total cash balance at the beginning of a chosen time period and enter it into your spreadsheet. To make things easier on your side, choose the start of a month as your entry point.

The starting cash balance is known as your opening balance.

If you’ve done a cash flow analysis before, take the ending balance from the last cash flow analysis as your opening balance.

2) Calculate your cash flow

Next, you want to add two sections to your cash analysis: cash inflows (money coming in) and cash outflows (money going out)

Then, you’ll need to insert three different categories into both of the sections (cash inflows and cash outflows will have the same categories)

The categories are:

  • Operating activities
  • Investment activities
  • Financing activities

Mark cash inflows as positive (+) and outflows as negative (-).

3) Calculate your operating activities

Operating activities are the financial activities that are related only to the operation of your business.

Inflows for operating activities include money that are received from sales or revenue from your clients. Money that is generated from your products or services should be listed in your operating inflows.

Operating outflows are things like your staff payroll or taxes that are not related to investments or financing.

4) Calculate your investment activities

Investment activities are financial activities that are not related to day-to-day operations, such as your business equipment, real estate or securities.

For example, money spent purchasing items such as a new office desk or a more robust CRM should be recorded in your investment outflow; money that you gain from renting your office space, for example, is considered as a investment inflow.

5) Calculate your financing activities

You may not have stocks in your business but it’s important to know that issuing stock to shareholders or buying it back, making payments on a business loan, or distributing dividends are all examples of financing activities.

If you got a loan for your business, the loan should be recorded as a financing inflow; however, each payment that you make on the loan should be recorded as an outflow.

Sum everything up

Once you’ve recorded all of the relevant transactions on your cash flow statement, add everything up to arrive at the closing balance which is the amount left at the end of the cash flow statement period.

If the closing balance is higher than the opening balance, you have positive cash flowIf it’s lower, you have negative cash flow.

Having a cash surplus isn’t always good

A common mistake among business owners is to think that having a positive cash flow is the best outcome that you can get from an analysis.

Actually, having a balance that is aggressively growing but with a lack of investing activities is a sign that your money isn’t used enough to grow your small business.

Remember, you need money to make money; you need to invest in your business with more staff or more assets when your cash flow allows you to do so.

Cash flow analysis empowers you to make necessary corrections to your business’ financial decisions which help you to maintain a sustainable business.

By having analysis that details key cash inflows and outflows, you get a clearer picture of how much cash is actually generated by your business, a better sense of your financing needs, and a glimpse into the growth potential of your small business.

How to make decisions based on your cash flow analysis

The more frequently you perform a cash flow analysis, and the longer you do so, the more you’ll learn from it. You’ll also begin to see important patterns in your business’ finances.

For example, you might notice that your cash flow is positive most of the time, but regularly becomes negative during the final week of every month. You may also spot that there is a dip in income every 3 months or so.

If you are unfortunate, you may also notice that you have a lot of overdue payments on your statement. This means you’re often short of cash, which is causing late payments and hurting your business.

By making a decision based on your cash flow statement, you can figure out logical ways to fix the problem. Usually, you can either cut your costs or increase your income when you are short of cash.

In the next section, we’ll discuss strategies and ideas to manage your cashflow efficiently.

How to manage your cash flow efficiently

Credit control

Setting up a good credit control system is not complicated. Essentially, you want your invoices to be paid as soon as possible – but it’s essential to put some procedures in place.

The basics include setting clear contracts and payment terms for your clients by sending out invoices promptly and firmly remind them when the invoice is due. You should also stay on top of client payments and be quick to stop offering lenient payment terms to clients with slow response times.

Sales forecasting

Sales forecasting is all about predicting what’s ahead so you can prepare for times when your cash flow are facing issues.

As soon as you have a month’s sales behind you, you can start forecasting cash flow – using your market knowledge, think about your pricing, the level of competition, the state of the economy and so on, to work out demand.

Remember it’s better to be overly cautious than optimistic – that way, you’ll avoid surprises along the way.

Cutting unnecessary costs and spend

When it comes to preserving cash flow, follow the lean startup methodology. Carefully examine every item you buy, know exactly where your cash is going and always get value for money.

Work out what you really need, too – those expensive paintings might look nice on your office wall but they won’t grow your business, yeah?

Negotiating good terms with suppliers

You won’t deal with this problem if you are service issue but it’s worth understanding it if you are going to deal with physical products in the future.

It’s always worth investigating to see if you can extend payment terms with suppliers particularly for large orders. If you can settle your bill in 60 days or even 90 days rather than 30, you get to hold on to your money for longer and this helps regulate cash flow in a business.

If you’re thinking about making a big order, don’t miss the chance to negotiate – could you set up a regular payment plan for example rather than paying off outstanding amounts in one go?

Don’t use up your cash too soon

If you’ve got new clients coming in, it’s always tempting to get the latest MacBook or splash out on an impressive new office chair. However, think wisely before spending your money on excessive purchases.

Always try to hold on to liquid cash especially if your clients have not paid you yet – you never know when a client will flake you at the last minute.

If you’re buying assets like computers, ask if the retailer will offer a finance deal over a year to keep your cash flow balance steady.

Keep on good terms with the bank

The economy is rough and it’s harder to get a loan than it used to be but it still pays to be on good terms with the bank.

Always keep your bank statements up to date so you can show your figures, just in case you need to borrow – and don’t forget, if you’re struggling with repayments, talk to your bank honestly rather than running away from debt

Invoice discounting

It won’t suit every business model but one way to regulate cash flow is to use invoice discounting, where a third party ‘buys’ your invoice and releases cash based on its value.

If you’re growing, it can be a good option and some lenders will give you up to 90 per cent of the invoice amount. Fees can be high however so always shop around – it’s a very competitive market.

Spot the warning signs

A sudden loss of clients, clients taking a long time to pay, late penalty fees from the bank and being forced to delay employee payments are all classic signs that your cash flow is suffering.

Don’t ignore the warnings – it’s generally easier to work out ways to increase working capital before you’ve built up a lot of debt.

Being realistic about your business

Sometimes you need to take a step back to see things clearly and running a business is no different. If you’re always struggling and your cash flow statement is poor, ask yourself why.

  • Are your sales too low?
  • Are your services poorly priced?
  • Can you chase payments more quickly?

Be level-headed about your venture and its future – if you’re not making a profit, you might need to rethink your business model.

Strategies to bring money into the business to improve your cash flow

Increasing sales through customer feedback

It’s common knowledge that your existing client base are the most valuable assets of your business.

They’ve already found you, chosen you over your competitors, and are familiar with your products or services. It’s also cheaper and easier to sell to existing clients than it is to attract new clients through direct sales or marketing campaigns.

Existing customers can be highly valuable when it comes to increasing sales.

So, how can you tap into your client base to sell more?

Gather their feedback

People who have bought from you are often the best judge as to what sells well and why, and from there, you can work out your most effective sales strategy.

By unearthing what your customers need and when, you can also predict demand. Try following up sales with a courtesy call or carry out a brief customer service call to get your client’s feedback.

Utilising social media

Don’t overlook social media sites which can be a cost-effective way to gather opinion from your clients.

Sound out new products or services with your followers on Twitter or Facebook, or check out competitor activity. If your niche or business organisation has an online forum, consider starting a discussion or thread to get feedback.

Cross-selling and up-selling

Consider how to exploit cross-selling and up-selling opportunities to your
existing clients by increasing either the range or the value of what you sell.

If you sell online, use your website and email marketing campaigns to make recommendations based on your clients’ buying habits.

Work out what your most valuable clients – the ones with a high customer lifetime value – really want from you. To encourage orders, you could offer discounts or special promotions on further purchases.

Using newsletters, e-mail outreach, and referrals

Alerting clients on your database through emails or newsletters when new, improved or related products or services become available is another
way of increasing sales.

You could also try to attract new clients through referrals – usually a highly reliable way to bring in new business – by giving incentives to clients who recommend your business to others.

Remember, no ones likes to be overly-badgered with sales pitches, particularly if the product or service doesn’t meet their needs.

Your marketing and sales campaigns need to be accurately targeted otherwise your target audience could lose their trust in you and this could jeopardise the buying relationship.

Your aim is to build a solid long-term association, not chase one-off profits.

Asking for payments when you are owed money

Unpaid invoices suck and they are a constant presence especially for service businesses.

Thankfully, there are some things that you can do to get your invoices paid as soon as possible.

Be clear and direct

When you’re chasing an unpaid invoice you’ve got to state clearly what you want to happen. Make sure the client understands your point of view.

Explain that you invoiced 30 days ago, the amount is now overdue and you expect to get paid by the end of the week.

Be nice, be firm

Be nice, stay calm but don’t be too kind. Some clients will push you to the back of their minds if they think you’ll put up with it. Being nice is important but remember – it’s about being clear and direct on your goal.

If you have to deal with the accounts department, be personable. Find out the person’s name and try to understand their point of view.

Do they only pay on certain days? Is the company struggling?

Treat everyone with respect, including the most junior assistant – it pays off.

Be honest and truthful

Only state facts about the contract, including when you invoiced them and your payment terms.

It’s incredibly important to get your facts right. If you sketch over the details – or worse, get them wrong – you’ll lose credibility and it’s easier for the client to ignore your requests.

Be persistent

Make regular phone calls with your client; e-mails can work too. If you want a physical meeting, suggest a meeting when they’re free.

It’s also helpful to get in touch often with them when you have the time. If contacting them is not possible, it might be because the decision makers for the invoices are not them, but the accounting department instead.

Whatever it is, don’t give up when chasing your invoices. One unpaid invoice will definitely lead to another – don’t let that happen.

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