- Cash flow is the money moving in and out of your business. Positive cash flow means you're earning more than you spend.
- Strategies for managing cash flow include invoicing customers in a timely fashion, offloading inventory that doesn't sell well, and closely monitoring where you spend money.
- Experts also recommend securing financing before you're strapped for cash and restructuring payments to free up cash.
- This article is for business owners who want expert advice on managing cash flow.
Proper cash flow management is a key strategy that every business owner must master for long-term financial success. Managing cash flow can be one of the biggest challenges business owners face.
A recent study from Intuit found that 61% of small businesses around the world struggle with cash flow. Nearly one-third of those surveyed are unable to pay vendors, loans, themselves or their employees because of cash flow issues.
To combat this struggle and stabilize your cash flow, you can incorporate several tactics into your business model.
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Why is cash flow important to a small business?
Cash flow is important to a small business because it shows how much money is actually moving in and out of your company, not how much money you're awaiting from accounts receivable. If your cash flow is positive, you'll know you're earning more money than you’re spending, and you'll have cash on hand to cover payroll, equipment purchases and upgrades, loan repayments and other key business needs. If your cash flow is negative, you may find yourself unable to pay your employees and suppliers, cover your monthly rent and have the money needed for any other daily business costs.
For these reasons and more, you should always prioritize cash flow strategies in your business planning. When you properly utilize such planning, you'll know exactly which times of the month you can expect money to be deposited into or withdrawn from your bank account. With this information, you'll know when you actually have the cash on hand to cover your expenses. Think about it like this: Even if you've invoiced a client for a substantial amount of money, you can't use that money until you actually have it, and cash flow strategies help you know just when that will happen.
An important element of your business model that can help with cash analysis is proper accounting standards. While businesses can run on a cash or accrual basis, Rohit Arora, CEO of small business loan provider Biz2Credit, advises every business to take advantage of both.
How does managing your cash flow affect your future?
Cash flow management is vital to your business’s success. If you can accurately project cash flow, you will steer your company in the right direction.
If you understand cash flow techniques, you can get ahead of the market. You'll even be able to predict cash flow, because you understand the revenue cycles of customers, vendors, suppliers and contractors.
Every business has high and low seasons; understanding upcoming expenses for employee overtime, replacement equipment and other needs goes a long way to ensure your business is well positioned to handle any bump in the road.
The first step is to determine the cash flow your business needs.
Jay Singer, senior vice president for small business at Mastercard, said that this is done by analyzing the current state of your business.
"It's important to understand how much cash you've been using and plan to use, as well as the length of time it will take to acquire more cash," Singer told Business News Daily. "While every business's needs are different, it would be wise to have enough cash on hand to cover up to six months of your average cash outflow."
How to calculate cash flow
One of the most important aspects of managing cash flow is understanding how to calculate it. There are three main formulas that can help you calculate cash flow: free cash flow formula, operating cash flow formula and cash flow forecast. Each formula serves a different purpose.
- Free cash flow refers to the resources available for distribution among all the stakeholders in the company. It shows you how much capital you have to reinvest in the business – such as purchasing new equipment, expanding your store, or investing in a new product for your company.
- The operating cash flow formula provides an at-a-glance view of the day-to-day cash flow within your business.
- The cash flow forecast provides a future look at your cash flow in the coming month, quarter or year.
All three of these formulas are essential to knowing how much money is flowing in and out of your business at any given time:
- Net income + Depreciation ÷ Amortization - Change in working capital - Capital expenditure = Free cash flow
- Depreciation + Operating income - Taxes + Change in working capital = Operating cash flow
- Beginning cash + Projected inflows - Projected outflows = Ending cash = Cash flow forecast
Projecting cash flow
Determining when you'll receive – and spend – money is part of the budgeting process. To successfully project cash flow, assess your prior year's numbers as a basis of cash flow for the following year. Then, adjust for anticipated changes, such as new pricing, and more personnel and funding sources.
As the year unfolds, you should update your cash flow projections to accurately reflect developments in expenses and profits. Comparing budgeted cash flows to actual deposits and expenditures helps you predict cash flow later.
Another strategy is to add the cash you already have to the money you plan to receive. Then add up how much of that money you anticipate spending.
Even the most successful organizations find that their forecasts change regularly, so it's important to monitor cash flow.
Preparing a cash flow statement
Cash flow statements are indicative of your company's health. They show that you have a healthy business capable of continuing operation at any given time.
You can find a lot of extensive breakdowns on cash flow statements. Here are some basic terms and elements of a cash flow statement you'll need to know in order to create and read yours.
- Cash from operating activities: This is how much money is flowing into your business. If this number is lower than net income or it's a negative number, this could be a problem.
- Cash from investing activities: This should be a negative number. This includes money your business has used to invest in itself and its products. Buying supplies or further developing your product are two examples of this kind of activity.
- Cash from financing activities: This area demonstrates how much money your company is spending to pay off certain obligations. This can include things like dividends.
- Net change in cash: This is how much cash your company gains or loses based on the investing and financing activities.
- Net cash: Net cash can be highlighted as beginning and ending balance. The ending balance is determined by applying the net change in cash to the beginning balance. The ending balance shows how much cash you have on hand.
How do you get positive cash flow?
Sales are obviously the best way for a business to gain cash flow. If you're not generating sales, you're not really a business. Of course, saving money in operational expenses helps, too. It's important to have detailed budgets and to curb unnecessary spending.
What should you do if you have a cash flow deficit?
In the event of a cash flow deficit, these are some of your options:
- Apply for a loan from a banking institution or individual.
- Apply for a line of credit from a bank.
- Speed up the collection process.
- Finance the purchase of equipment through leasing or loans.
- Liquidate assets.
- Delay payments to vendors.
Sometimes you may have a surplus of cash. That money can affect future opportunities, so you don't want it to sit around. Accountants recommend that you make the surplus work for you. You can do this by making short-term investments and using the money to pay off debts faster. That way, the money will benefit you through generated interest or shorter loan terms.
Always consult with a professional accountant before making major financial decisions that could impact the future of your business.
9 ways to manage cash flow
The most important aspect of managing cash flow is to constantly monitor it. You need to know how much money your company is taking in as well as how much of that money you have on hand to use. If you have an accurate idea of your company's cash flow, you can follow these simple tips to increase cash flow and manage your business.
1. Don't wait to send invoices.
Again, a key reason cash flow matters is that it distinguishes between invoices you've sent and invoices that have actually been paid. That $10,000 invoice means little if you don't yet have that money on hand to cover your expenses. That's why you shouldn't hesitate to send invoices.
You may want to shift from a monthly invoicing model to one in which you send invoices every time you complete a certain amount of work. For example, if your small business is an advertising agency, send your invoice not on Nov. 30, but whenever you complete a preset number of campaigns, ad spends or other initiatives that month.
2. Adjust your inventory as needed.
Check your inventory to identify items that aren't selling well. These products harm your cash flow, as the cash you've spent to obtain them isn't converting to sales and thus revenue. You can address this cash flow concern by selling these less frequently purchased items for discounted prices and not buying additional stock after you deplete what you currently have. Similarly, you can always invest more into stocking items that do sell well.
3. Lease your equipment instead of buying it.
Even though it's usually cheaper over the long term, buying new equipment and updating outdated equipment can be costly in the short term (not to mention time-consuming). Leasing your equipment instead can lessen your short-term financial burden. You won't have to upgrade or try to sell outdated equipment that you've purchased, and equipment leases often qualify for tax credits that lower your tax burden. As such, you'll have less cash leaving your bank in large lump sums, and maintain a more regular cash flow.
4. Borrow money before you need it.
The best time to solve a cash flow problem is before it happens. If your business is running smoothly or is in the beginning stages of production, now is the time to borrow money. By opening a business line of credit when your numbers are good, you can avoid the risk of rejection later. This will also provide you with resources to fall back on should you experience any growing pains associated with starting a business. Arora said that a business line of credit can be a lifeline for small businesses, particularly those impacted by seasonality.
"Whatever amount you think you will need, ask for double; you might not get it, but it's better to have reserves to draw from when times get tough," he said. "If you can get a small business loan at 10% or less, your cost of capital will be so much lower than if you put purchases on credit cards that carry rates of 19% or more."
For businesses that have already been consumed with high-interest credit card debt, Arora recommends refinancing. For example, if you made several purchases on credit cards that come at interest rates of 20% or more, consider getting a business line of credit, which might be available for as low as 6% or 7% interest.
If you have yet to open any credit cards and are struggling for a loan, Singer suggests getting a small business credit card with an interest-free grace period to support your short-term financing needs. He said that credit cards can highlight opportunities to save and that many even come with innovative reporting options that illustrate spending trends to help business owners optimize their cash flow.
5. Reevaluate your business operations.
Continually review your cost structure to find efficiency gaps and implementations that can be modified to increase savings. Arora suggests identifying parts of the operation that can be outsourced to freelancers and third-party providers. This will allow you to get the job done without providing salary and benefits. He also suggests that businesses scale back part-time staff during slow periods.
Alex Shvarts, CEO of FundKite, recommended monitoring, evaluating and improving other areas of operation in addition to outsourcing.
"Certain areas of business operations can be reevaluated and updated for efficiency," he said. "[These include] shipping costs, use of middlemen, extra employees, allotted overtime, marketing returns, overdue invoices, rented equipment payments, stocking up on materials when tariffs are low and potentially asking vendors for a break."
As the economy changes, your business strategies will change, too. Always look for ways to improve your product and invest in smarter solutions.
6. Restructure your payments and collections.
Depending on whom you're working with, you may be able to put off some payments to your vendors until your business is financially healthy. Do your best to maintain a healthy relationship and avoid late fees.
Restructure your payments to your vendors to create a more balanced income for your business. By doing this, you can turn your vendors into lenders. If you are unable to restructure payment dates, consider restructuring payment costs. You can do this by meeting with new vendors that can potentially provide inventory and supplies at a better cost. Arora said that even if you are not looking to replace your current vendors, you can use the information from competitors as leverage to get better pricing.
You can also benefit from restructuring how your employees are paid. Although it's a minor detail, how often your business runs payroll can provide some cost savings. Shvarts said that switching to a less frequent pay schedule can save on the administrative costs of collecting, verifying and tabulating payroll information. Implementing direct deposit can help stabilize your payroll withdrawals as well. If you already have a payroll system in place, be sure to assess any fees associated with changing the frequency.
Choosing the best debt collection process can make a big difference as well. It is important that you are prompt on your collections and take aggressive follow-up action on past-due accounts receivable when necessary. Set up a continual collections process of reminding accounts receivable when and how much they owe you. Invoices that slip through the cracks can add up.
7. Monitor where your money is going.
Taking on debt isn't always a bad thing. Sometimes borrowing money can be a temporary fix until your business is healthy enough to make it on its own. However, anytime you take on debt, you should carefully monitor and evaluate the extent of your cash flow.
"While taking on debt can be key to coasting through hard times, a business should still calculate how much debt they can take on as to not be overleveraged," Shvarts said. "The debt will be paid back either through investing in growth or once an invoice is paid by the client, but those both require factoring in time, interest, ROI and more."
Strategically borrowing money can be a viable option, as long as you have a repayment plan in place. You should monitor your other expenses and make changes where needed. You may have to shift from a long-term investment mindset, such as buying equipment, to a short-term survival mindset, such as leasing equipment.
Alongside examining your debt and expenses, you should monitor your savings. Although balancing growth capital and working capital can be difficult when working with thin profit margins, Shvarts said it's important to maintain a rainy-day reserve. If you don't have a business savings account, it may be time to reevaluate your profit structure.
"Keep reserves of extra cash, not just for hard times, but for when a growth opportunity comes along or financial flexibility is needed," Shvarts said. "Growing a business greatly strains cash flow, [since] you have to invest and bring on expenses before the higher revenue kicks in. By all means, grow, expand, turn your small business into a big business, but still save some money for an unexpected market dip while you're in the process of expanding." [Related: Leverage software and technology by utilizing the best accounting software for small businesses.]
8. Take advantage of technology.
As a business owner, you should take advantage of technological advances and artificial intelligence-enabled solutions, like new apps and software updates. These can streamline your business processes and increase efficiency. Although technology can help with any sector of your business, Shvarts specifically recommends using it to create budgets and project cash flow.
"When you can see all accounts payable and accounts receivable, plus the other financial intricacies of your business, in one spreadsheet, you can budget and easily project future cash flow," he said. "Depending on which software you choose, your information will be secure in the cloud, so you won't risk misplacing or damaging paper documents."
The right technology and the right business strategies can make a big difference for your company. They allow you to spend less time worrying about cash flow and more time running your business. If you don't feel confident in overseeing your cash inflow and outflow, you can always hire a CPA or bookkeeper to do it for you. Regardless of who manages your cash flow, it needs to be done.
"The point of running a business is to make sure your revenues exceed your expenses and to generate a profit," Arora said. "Managing cash flow is critically important to running a profitable business [for the] long term."
9. Consider loan options.
Sometimes, all a company needs is a quick cash injection. Look at what line of credit, business loan and other financing options are out there. Invoice factoring and invoice financing are also great ways to get advanced payment on outstanding invoices. It can help your company get the money it deserves earlier than a client is willing to pay. Remember, you should be taking on debt only if it's advantageous for your company.
Max Freedman contributed to the writing and reporting in this article. Source interviews were conducted for a previous version of this article.