Knowledge is power, and the more you understand about small business cash flow management — see its challenges and learn to thrive on its potential — the less likely it is that your business will become another doomed statistic.
Poor cash flow is the number one reason small businesses fail, according to nonprofit SCORE. Their research finds that 82% of small businesses fail due to cash flow problems.
Jump ahead to learn more about:
Cash flow is money coming in and out of your business, and that cash can ebb and flow in three different buckets:
Operating cash flow is the day-to-day money your business generates and spends. It’s the cash you generate from selling your products and services. It also includes your regular expenses such as your costs for supplies, employee payroll, a commercial lease and business insurance.
Calculating your operating cash flow helps you gauge your profitability. It’s an overall indicator of your company’s financial health and performance.
This is the money spent and generated on your business investments. (The fancy term is “capital assets.”) It could be the purchase of long-term assets such as property or equipment. It also covers acquisitions or the sale of a business.
Depending on your industry, you could have a lot or very little/none of this cash flow.
Financing cash flow is the money that moves between a business owner, investors and creditors. This includes debt, equity, dividends or any other financing arrangement.
Depending on your business, you might not have this type of cash flow. However, it’s important because it’s another indicator of financial performance — even if your operating expenses aren’t positive.
For example, positive cash flow could indicate that more money is coming into the business, which increases assets. It can also mean that the business isn’t earning enough and the owner needs to borrow more. Negative cash flow could also indicate that you’re repaying debt, which lenders and financial institutions may like to see.
Cash is the lifeblood of your business and your key to its success. Without generating enough cash to pay your expenses, you won’t be in business for long.
But it’s not all about profitability; profitability and cash flow are different. A successful business hinges on the right balance between earning and spending.
For instance, lots of cash on hand is nice, but you could be missing out on investment opportunities that generate more earnings.
Conversely, if you never seem to have enough cash, you might struggle to pay bills and gain momentum. Consistent shortfalls can spiral out of control and quickly put you out of business.
That’s why cash flow management is crucial — it helps you meet both short-term and long-term needs.
Although your small business is unique, these five common cash flow problems often crop up. They include:
1. Not keeping enough cash reserves. Keep at least three to six months of working capital in place as a buffer.
2. Not making a cash flow business plan. Include the strategy you’ll use to deal with a gap between your outgoing and incoming cash flow.
3. Growing too fast. If your business grows too fast, you could find your cash flow tied up in upfront costs.
4. Improperly tracking cash flow projections. Monitor your incoming and outgoing cash at least once a month — possibly weekly or even daily.
5. Incorrect and unprofitable pricing. If you charge too much, you scare off customers. But if you charge too little, you earn less and customers may not value your products or your brand enough.
These vocabulary words are often used when we talk about cash flow management:
1. Accounts payable. The money a business owner owes to vendors and service providers.
2. Accounts receivable. The money customers owe a business from delivering goods or services.
3. Assets. A resource you own or control that can be used to produce positive economic value (e.g., cash, office equipment, property, inventory etc.).
4. Break-even point. The point where your total cost and total revenue are equal, meaning there is no loss or gain for your business.
5. Burn rate. A measurement of negative cash flow. This is the rate at which your business uses up (or “burns”) its venture capital before the business becomes profitable.
6. Cash flow analysis. An examination of a company’s cash inflows and outflows to determine the amount of money available to run the business.
7. Cash flow statement. A financial document that summarizes the amount of cash entering and leaving a company during a given period.
8. Free cash flow. The money you have leftover after paying your operating expenses and obligations.
9. Liabilities. The debts your company has. (e.g., bank loans, mortgages, unpaid bills etc.).
10. Liquidity. The measurement of how easy it is to sell an asset for cash. A liquid asset can easily be converted into cash quickly without losing value.
11. Negative cash flow. When the business is spending more money than it generates.
12. Positive cash flow. When the business is generating more money than spending.
Whether you’re a new small business owner or a seasoned pro, brush up on your cash flow management practices.
Many of today’s accounting software, such as QuickBooks, have powerful and intuitive user interfaces, and you don’t need to be an accountant to use it. Software can track all your accounts, transactions, balances, generate invoices and streamline taxes.
Also, accounting software doesn’t have to be expensive. For example, you can use free, open-source accounting software like Wave or GnuCash.
Open an interest-bearing business bank account that serves as your central cash reservoir to put your cash to work for you.
It’s a common mistake to lock cash into a 30-day or 60-day CD bond. Keep it in an immediate-access account in case of a cash flow forecasting miscalculation or an unexpected event.
One of the best ways to improve your business’s cash flow is to train your customers to pay you on time. Online invoicing software like Due or Invoice Ninja sends automatic payment reminders. Also, one-click payment options make it easy for customers.
Don’t forget to invoice promptly. Most invoicing software can generate and send an invoice to customers.
The later you send payment to vendors or suppliers, the longer your cash is available and earning interest for you. Digital banking can automate payment of recurring expenses on the final day they’re due before you get hit with a late fee.
You might also be able to negotiate early payment discounts with suppliers if you find yourself with a positive cash flow.
Making all your payments on the same day might be easy to remember, but it’s terrible for cash flow management.
Check for monthly payment options for fixed costs such as general liability insurance. NEXT offers this option because we know many small businesses prefer to pay monthly instead of one lump annual sum.
Software like Gusto and Square Payroll is important for your business financial management. If you have a payroll account, transfer funds just before paying salaries so that your cash stays in your main interest-earning account for as long as possible.
Try to pay employees via direct deposit to save money and time processing checks.
Decide which payroll cycle structure works best for you. A bi-monthly cycle (paying twice a month roughly 15 days apart) means you have 24 pay cycles each year instead of 26, saving you the cost of two pay cycles. However, a bi-weekly cycle (usually the same day every other week) allows for smaller paychecks each pay period.
Some ideas to help reduce small business expenses include:
Inventory ties up cash in tangible objects. Turning it over frequently helps to keep cash flowing.
For instance, track your inventory levels in real time either manually or through a point-of-sale system. Set reorder alerts to notify you when a product runs low. Or look for inventory management tools that can regulate inventory and ordering on sales amounts and frequency.
Keep emergency cash reserves for your business and open channels to more cash.
Keep an eye on your business credit score so you can get favorable terms on a business loan or a business line of credit, if needed. A business credit card can also boost your business credit score and give you a source of emergency funding.
Finally, get business insurance to help protect your business from accidents or mistakes that can result in financial loss. Insurance can help cover some costs such as medical expenses, property damage, legal fees and more up to your policy limit.
NEXT can help small business owners get affordable, tailored business insurance to help protect their financial interests.
Apply for insurance online, get a quote, see your policy options and purchase coverage — all in less than 10 minutes. Access and manage your account and a certificate of insurance 24/7 via web or mobile app.
If you have questions, our licensed, U.S.-based insurance professionals are available to help you.
Start a free quote with NEXT today.
Kim Mercado is a content editor at NEXT. She writes and edits content for small business owners, and enjoys helping entrepreneurs solve their business challenges and learn about insurance. Kim has contributed to Salesforce, Samsara and Google.
You can find Kim trying new recipes and cheering the 49ers.
