Cash flow is the life’s blood of small businesses. Insufficient cash flow can snowball into a serious financial problem because it can cause late payments, make vendors unhappy, and even make it difficult to attract investors.
Select Funding works with small business owners every day and because we specialize in small business financing, cash flow is a frequent topic of conversation. People understand what cash flow is, but often ask us this question:
“What is cash flow management?’
Here’s what you need to know about cash flow management plus nine cash management principles that you should follow.
What Does Cash Flow Management Mean?
Cash flow is the term used to describe money flowing into and out of a business. Businesses measure cash flow by making note of the cash available at the beginning of a chosen time frame and at the end and comparing the two. A business has positive cash flow if the amount is larger at the end of the time period than it was at the beginning and negative cash flow if the reverse is true.
Types of Cash Flow
There are three basic types of cash flow that must be taken into account when measuring and managing cash flow, as follows:
- Cash flow from operating activities includes cash coming in or going out as the result of selling products or providing services.
- Cash flow from investing activities includes cash coming in or going out from investments you’ve made, including interest and dividends.
- Cash flow from financing activities includes cash coming in or going out from financing you’ve obtained, whether it’s from a private investor, a venture capital firm, a lender, or from short-term financing such as accounts receivable factoring.
All three types of cash flow must be tracked and accounted for with proper cash flow management.
What is Cash Flow Management?
Cash flow management is a process that enables businesses to track the ebb and flow of money in their business, including both cash and non-cash payments.
Proper cash flow management allows businesses to optimize the flow of money and its use by making sure that there is enough cash on hand to pay for necessary expenses and to pursue the company’s growth goals.
What is the Importance of Cash Flow Management?
Cash flow management is essential for small businesses because it can benefit them in a variety of ways:
- It can reduce stress. A lack of cash—or worrying about a lack of cash—is a common source of stress for small business owners. Having a cash flow management system in place can remove most of the stress because it makes it easy to see how much cash you have on hand and to make decisions accordingly.
- It can help you predict shortages. Every business experiences ebbs and flows of cash and shortages can be extremely stressful, especially if you don’t see them coming. With effective cash flow management, you can forecast shortages—sometimes months ahead of time—and make arrangements to accommodate them.
- It can improve the accuracy of your budgets. Budgeting is essential but only if budgets are well-thought-out and accurate. If you budget too much money, then issues can arise if you don’t have the cash flow to meet your budgetary commitments. Cash flow management takes a lot of the guesswork out of budgeting.
- It builds trust. Investors like companies to have a handle on their cash flow because it demonstrates financial responsibility. With vendors and suppliers, cash flow management can help you communicate payment timetables and build trust to get some flexibility when you need it.
- It makes business growth possible. There’s no way to grow or scale your business without cash flow, whether it comes from operations, financing, or some combination of the two. When you manage your cash flow properly, you can do a good job of planning for growth because you’ll know what to expect.
It’s easy to see that proper cash flow management can help small business owners run their companies effectively and achieve their business growth goals.
9 Cash Flow Management Principles for Small Business Owners
If you want to improve your business cash flow, here are nine important cash flow management principles and best practices to help you.
#1: Collect Receivables Quickly
One of the most important things you can do to optimize your cash flow is to make accounts receivable a priority. Some of the things you can do to expedite collections include the following:
- Send invoices immediately
- Allow customers to pay electronically or with a credit card
- Offer discounts for rapid payments
- Have a system in place to follow up when invoices are due
- Institute penalties for late payments
Doing these things will incentivize your customers to pay as quickly as possible and minimize cash flow fluctuations.
#2: Be Careful Extending Credit
On a related note, you should be careful when extending credit to customers. Never do so without running a credit report and even if the customer’s credit is good, limit credit according to what you see on their report.
It’s extremely important to maintain good boundaries around credit, too. Don’t overextend someone’s credit to make a sale. You can always negotiate a payment and accept it via credit card if one of your customers needs additional products.
#3: Pay Your Bills Strategically
Every business has financial obligations and good cash flow management means doing what you can to strategize accounts payable to optimize your cash flow.
For example, you may want to arrange the due dates for some bills to smooth out your cash flow. Assuming your rent is due on the first of the month, you can call utility companies and service providers and ask to change your billing cycle to have due dates in the middle of the month.
#4: Choose the Right Payroll Cycle for Your Business
Payroll may happen weekly, biweekly, or monthly. When you look at the big picture of your company’s cash flow, it may become apparent that a biweekly payroll cycle is more advantageous to you than weekly payroll.
As a rule, companies with daily cash flow are best able to handle a weekly payroll cycle while those with slower revenue streams may prefer a biweekly cycle. Make sure to check with your state’s Department of Labor to verify that you are meeting your legal obligations.
#5: Negotiate Terms with Your Suppliers
Another way of being strategic about cash flow is to talk to your suppliers and do what you can to negotiate payment terms that align with your revenue streams. There are multiple options to consider, including payment discounts, longer or shorter terms, and volume discounts.
If you need some wiggle room with revenue, you also have the option of paying with a credit card if your supplier allows it.
#6: Monitor Your Cash Flow Closely
Cash flow management is most effective when it is a regular part of your business operations. You can use balance sheet software and other tools to monitor and project your cash flow, thus taking a lot of the guesswork out of better cash flow management.
You can get the most accurate picture of your cash flow by tracking cash flow metrics and KPIs. Some examples include Working Capital, Operating Cash Flow, Forecast Variance, Accounts Receivable Turnover, and Current Ratio.
#7: Address Cash Flow Issues Early
One of the biggest benefits of regular cash flow management is that it makes it possible to address cash flow issues early. Taking a proactive approach can prevent a small cash flow problem from becoming a large one.
An example of this principle in action might be forecasting a cash flow shortage in the coming month and calling a supplier to request leniency on a payment. People are far more likely to accommodate such a request if they’re asked about it in advance instead of hearing about it when your invoice is already past due.
#8: Build Up a Cash Reserve
Cash flow management can do a lot to smooth out cash flow and help you manage revenue, but that doesn’t mean you shouldn’t have a contingency plan in case of a cash flow crisis. Having an emergency cash reserve can take a lot of the stress out of running your business.
Just as is the case with personal finances, we suggest striving for a reserve large enough to pay for six months of operating expenses, including rent, payroll, supplies, and utilities. Dip into the reserve only when necessary and replenish it as soon as possible.
#9: Don’t Grow Too Fast
Healthy cash flow is essential for business growth but it’s important not to grow so quickly that you outstrip your cash flow. It can help to have a business growth plan in place that allows you to ramp up your spending in a controlled way to fuel your growth.
If growth is a priority, you may want to add to your cash flow with affordable small business financing. Select Funding offers business financing based on your company’s monthly deposits, making it easy to get the working capital you need to grow your business.
Get the Cash Flow You Need to Achieve Your Business Growth Goals
Cash flow management can help you get a handle on your small business finances and use the money you have coming in to fuel your growth goals without straining your revenue.
Are you seeking small business financing to help your business grow? Select Funding provides affordable financing based on business deposits. Click here to learn more.
