A Comprehensive Guide to Understanding Small Business Cash Flow

As a small business owner, you may already have come across the term ‘cash flow’. We examine why it is the lifeblood of business and how it affects your business finances.

What is cash flow

Cash flow is the virtual or real movement of money, mainly concerned with cash inflows and cash outflows. In short, cash flow is the net amount of cash that comes into or goes out of your business within a set period of time. An easy way to think of cash flow is it represents all the financial transactions using the business’s cash.

Positive cash flow happens when more cash is coming in than heading out. That’s to say, there’s more cash inflow than outflow, so you have enough money to satisfy the business’s needs. On the other hand, negative cash flow is the opposite of that. It is a situation where more money is leaving the company than it can make, negatively affecting the cash balance. That causes cash flow shortfalls, leading to cash flow problems.

Similarly, you may have come across accounts payable and accounts receivable. Accounts payable are liabilities as it means you need to pay debtors. On the flip side, accounts receivable are assets since this is money owed to the business for goods or services supplied on credit.

The accounts receivable account helps keep track of money coming into the business. It is essential when calculating the business’s profitability. In contrast, accounts payable keeps track of all the money leaving your business in the form of business expenses.

Another term to look out for is free cash flow which is the cash you will have after deducting cash outflows or operating expenses and capital expenditures. All these terms are crucial for determining cash flow.

Accounting work with cash flow management vector illustration.

Why is cash flow important for a small business

One of the best ways to indicate the financial health of your business is by looking at how much money you have on hand. Think of cash flow as the lifeblood of the company. Positive cash flow will make a business flourish as it becomes easier to settle expenses on time.

A quick peek at the balance sheet will reveal the cash flow statement and income statement – a positive report from those two indicate the company is in rude financial health.

You will likely see more money leaving the business than coming in at the startup phase. Consequently, over 80% of small businesses fail because of cash flow problems. However, this is because of the high initial cost of setting up the business.

That said, the main reasons why cash flow is vital to your business are:

  • Keep track of the flow of money
  • Manage late payments
  • Helps in growth and expansion
  • Can help in better planning, budgeting, and decision making for all business needs
  • Stop overspending

Importance of cash flow management in a small business

Improving cash flow management helps keep the business running, even while waiting for accounts receivable payments. Managing cash flow is all about ensuring that the business’s capital is put to good use through:

  • Balancing cash inflows and outflows accurately
  • Reducing the amount of cash on hand
  • Ensuring that money goes toward value creation and maximum return on investment
  • Maintaining enough working capital to cover the company’s financial obligations and unexpected expenses

Actionable cash flow strategies for small businesses

Despite cash flow management issues that small businesses run into, there are strategies you can employ for effective cash flow management:

i) Find a software solution

Attempting to calculate everything yourself is time-consuming and leaves room for error. Instead, you can invest in accounting software or apps that will help optimize the cash conversion cycle and payable days.

Cash flow management apps or accounting software provide advanced data management and analytics, process automation, and other artificial intelligence features. These tools allow you to capture, organize, and analyze cash data accurately. The software also showcases spend visibility, crucial for accurate cash flow forecasts.

Accounting software stores data in the cloud, making it easily accessible to you or any other appropriate personnel. Storing data on the cloud has the added advantage of accessibility from any location.

Lastly, cash flow management software encourages healthy spending habits and strategic decision-making designed to improve cash flow over time.

ii) Create a cash-savvy environment and culture

To ensure proper financial management, small business owners need to ensure that everyone working in the company understands the importance of cash flow management.

It is not just the work of the accountant or the business owner to ensure that employees use money efficiently. Encourage everyone to make healthy financial decisions.

Develop and implement financial policies that instill discipline and encourage strategic spending. These policies will make it easier to monitor and identify key problem areas in cash flow management.

iii) Borrow money before needing it

Don’t wait until you’re in a financial crisis, with a negative cash flow to boot, to borrow money. Even when the business is running smoothly with no looming financial threat, you still want to ensure you borrow money in advance. Do so when your credit score is good, as banks will easily open lines of credit for you.

It also gives you peace of mind knowing that there is money to fall back on should the business run into financial challenges. A line of credit often saves a small business from collapsing. You can acquire business loans with a reasonable interest rate if you have a good credit score.

iv) Send invoices early

Since most customers don’t have the cash flow to pay upfront, don’t delay sending invoices. That $5,000 invoice means nothing to the business if you do not have that cash on hand. Cash flow management is vital because it helps identify sent, paid, and unpaid invoices and push for early payments.

Most businesses prefer using a monthly invoicing model. Still, smaller businesses should send out invoices when they complete a particular milestone. It works exceptionally well if you often meet a client’s targets earlier than expected.

v) Improve your inventory management

Deadstock or inventory negatively impacts your cash flow. That’s because the money you used to purchase them is not converting into revenue. Find out what products sell the most and prioritize stocking these items first.

Also, if you have slow-moving inventory, offer discounts to lure buyers and make the sale. Afterwards, avoid restocking those items and instead focus on selling the faster-moving products.

vi) Lease equipment instead of buying it

It may seem counterintuitive because purchasing your equipment will be cost-effective long-term. However, purchasing new equipment or upgrading old equipment is often out of reach for small businesses with limited working capital.

Lease equipment to minimize the short-term financial burden. Doing this will also ensure you have enough positive cash flow to run the business. Another advantage is that equipment leases help you qualify for tax credits, lowering your tax burdens.

vii) Reevaluate business operations

Continually assess your business operations to identify gaps that can increase savings. For instance, hire third-party companies or freelancers to work on tasks on a short-term contract instead of a full-time basis. Hiring freelancers ensures you still get the work done without paying salaries and benefits. Another practice you may have to acquire is cutting back on part-time employees, especially during slow seasons.

Other areas to evaluate in business operations include go-betweens, allotted overtime, overdue invoices, marketing returns, extra employees, shipping costs, and rented equipment payments. You can also ask vendors for a payment break.

Conducting a cash flow analysis for small businesses

Cash flow analysis involves looking at the liquidity and solvency of the company. There are three types of cash flow that you need to know about: cash flow from investing activities, cash flow from operating activities, and cash flow from financing activities. You will find these in the company cash flow statement. Conducting a cash flow analysis allows you to look at a business’s financial health critically. The analysis will ascertain whether the money comes from loans, sales, or investors.

While it is normal for a new business to experience a negative cash flow, the cash flow analysis will pinpoint the depth of the problem. That gives lenders and investors a basis for deciding whether to finance the company or not.

Importance of cash flow analysis

A cash flow analysis helps determine a business’s working capital. You can conduct a cash flow analysis by subtracting current liabilities from current assets. A cash flow analysis shows whether your business can generate money to pay bills and stay afloat. While a positive cash flow is good for the company, negative cash flow over a prolonged period can lead to bankruptcy.

Basics of cash flow analysis

Before conducting a cash flow analysis, you must prepare a cash statement to generate investing cash flow, operating cash flow, and financing cash flow.

-Operating activities – This is money received from customers less money spent on operating expenses. It includes recurring expenses such as utilities, supplies, salaries, and rent. - Investing activities – These are statements reflecting funds spent on financial instruments and fixed assets. Fixed assets include long-term investments like property and stock. - Financing cash flow – Refers to any money coming from the business’s investors, owners, and creditors. You’ll find it credited as equity, debt, and dividend transactions on a cash flow statement.

Steps to performing a cash flow analysis

Prepare the cash flow statement: Before conducting a cash flow analysis, you must first prepare a cash flow statement. Some line items to include in a cash flow statement include:

  • Money received from the sale of services or goods
  • Employee wages and bonuses
  • Purchase of supplies or inventory
  • Payments to contractors
  • Cash or fine settlements from lawsuits
  • Utility bills, lease or rent agreements
  • Interest paid on loans

There are two ways to calculate the operating activities section of the cash flow statement. These include:

a) Direct method – involves calculating cash collection from all the operating activities. Next, subtract cash payments from the operating activities to get the net income.

b) The indirect method – start with net income, then add or deduct expenses and non-cash revenue.

You prepare the investing cash flow statement by adding money from the sale of stocks and assets, and paying back loans, and then deducting money used to buy assets and stocks. The financing cash flow statement shows the movement of funds between a business’s owners and its creditors and investors.

Cash flow analysis in three steps: There are several factors to look out for as you analyze the business’s financial health.

  • Always aim for positive cash flow. When the operating income exceeds the net income, that is a strong indicator of its ability to grow its operations and remain solvent.
  • Be cautious about positive cash flow. For example, this can show that the business is selling off assets to pay for operating expenses, which is not sustainable—instead, lookout for a negative operating cash flow with a positive investing cash flow.
  • Analyze the company’s negative cash flow. A negative cash flow does not necessarily mean that a business is doing poorly; for instance, if a business uses the money to purchase new equipment or invest in property that will eventually generate more money. In short, this analysis will show that a company is making profits but is using the same earnings for its growth.

Typical cash flow challenges in small businesses

Sometimes, cash flow issues are unavoidable when running small businesses. It’s essential to constantly keep an eye out for any developing cash flow issues you may have. Below are the common small business cash flow problems you may run into:

1) Unrealistic startup estimations

If you are just starting a small business, have a realistic budget. Always budget for overages. Business startups cost a pretty penny, and you’ll likely make several outgoing payments before receiving the first incoming payment. Without a cash reserve, you can quickly run into cash flow problems.

2) Expecting profits too quickly

As a budding entrepreneur, you may expect to make profits from the moment the business starts operating. However, a study conducted by Jessie Hagan of US Bank shows that 82% of businesses fail because of cash flow problems. So, you should anticipate experiencing cash flow problems within the first few months of operations.

You have a 68% chance of reaching profitability within the first year. It takes time and grit to build a profitable business, and cash flow issues will initially be a part of it. Having a cash reserve can help cushion you in the months before the business hits profitability.

3) Not having a cash flow budget

A cash flow budget or forecast estimates the amount of money you expect to receive and the amount you expect to pay during a specific period. Say you want to make a cash flow budget for the next 60 days: in that case, estimate how much money the business will receive or spend within that time frame. Having a budget like this helps give better insight into the business’s financial health. You’ll be able to make astute cash flow projections by knowing when to make payments and expect outstanding receivables.

4) Accumulating too many slow receivables

A business can become profitable quickly, but slow-paying customers create cash flow problems. Sales might be through the roof, and bookkeeping shows that the business is making massive profits, yet there is little cash on hand. Slow receivables create a negative cash flow, making it challenging to cater to the business’s expenses in time. Do not open a line of credit for customers until they have a proven record of making payments on time; this will help prevent cash flow problems from slow receivables.

5) Ignoring high overhead costs

If there are too many expensive overhead costs, you will experience cash flow challenges. Expensive travel, unreasonable car leases, and high rental costs can quickly eat into your profits. High overhead costs will cause you to sell more to cover these expenses to break even.

Try to reduce overhead costs as much as possible to help save whatever profits your business makes.

6) Growing too quickly

There is nothing wrong with wanting to grow the business quickly. Still, too fast growth causes cash flow issues, ultimately hurting the company. For instance, you may land a large client with a workload that requires an extra set of hands. Fair enough, you hire three people to help with the client’s order. However, you do not have enough money to pay the wages on payday because the client hasn’t settled the invoice yet. That sentences you to negative cash flow, and it’s just one example of wanting to grow your business too fast, too soon. To fix this problem, you could acquire a line of credit like a short-term small business loan.

One of the easiest ways to deal with constant cash flow problems is to let another company shoulder the risks for you. A company like Resolve provides solutions for cash flow problems by offering cash advances and managing your net terms.

Resolve will set the payment terms for every customer after conducting smart credit checks to weed out undeserving clients. Some of the incentives for using Resolve include a net terms management team taking care of all the processes without you needing to lift a finger and cash advances up to 90% of the invoice’s face value.

In addition, Resolve provides a handy payment portal with convenient payment options, such as a bank account or business credit card. Even when clients fail to pay after the 30, 60, or 90 days payment terms, Resolve will chase after the payment, not you.

With Resolve, you will never have to worry about experiencing cash flow problems because of their handy net terms solutions. It leaves you with enough cash to run the business, even if clients haven’t cleared their invoices yet.

Final word – ways to resolve cash flow issues

Even though small businesses have a higher chance of facing cash flow problems than more established ones, there are still solutions to help solve these problems.

Some of the best ways to resolve cash flow issues include sending invoices to clients as soon as possible, using accounting software or apps, and improving inventory management. Additionally, you can lease equipment instead of purchasing, borrowing money before you need it, and utilizing companies like Resolve can advance you up to 90% of the value of an invoice while taking care of the net terms.


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