When you’re a business owner, cash flow is your lifeblood. To keep your business operating smoothly, it’s essential to ensure you have more money coming into your business than going out.
And while effective cash flow management is fundamental to a business’ success, it’s not uncommon for business owners to struggle with cash flow problems. In fact, 60 percent of small businesses fail due to cash problems. In other words, if you’re worried about cash flow, you’re not alone.
To help you stay on top of it, we’ve broken down the basics of cash flow management and put together tips so you can ensure financial health for your business.
What is cash flow management?
Cash flow management refers to the process of tracking money that comes in and out of your business. By tracking these funds, you can forecast how much money will be available to your business in the future, and how much you’ll need to pay in expenses.
To help you manage your cash flow, it’s critical to reference your cash flow statement, which is used to report the cash generated and spent during a specific accounting period.
Why cash flow is important
It’s important to pay close attention to cash flow each month to ensure you have sufficient cash on hand to pay operating expenses such as payroll and suppliers. If you don’t have access to cash, you can end up with unpaid bills and late salary payments for employees.
To avoid this, you need to carefully manage your cash flow each month to focus on creating a positive cash flow, meaning you have more money entering your company than leaving it each month.
A cash flow statement gives you insight into where money is coming from, when it’s coming in, and how it’s being spent, so you can analyze your company’s financial status and budget for the future.
4 common misconceptions of cash flow management
When it comes to cash flow management, there are a few common misconceptions that can be misleading for business owners, including:
- Profits equal cash flow.
While profits represent money that’s coming in on paper, they don’t represent the current cash on hand. Even though you may have a profitable month, those funds aren’t usually available right away, so it doesn’t translate to a positive cash flow.
- We have strong accounts receivable; we don’t need to worry about it.
Similar to profits, accounts receivable do not equal cash. They’re simply promises from customers to pay money owed at a future date.
- Cash flow management is too complex for my small business.
Regardless of your business size, monitoring your cash flow is necessary. In fact, cash flow can be even more important for small business owners, since their funds may be tighter, with less of a buffer for unexpected costs.
- Cash flow planning can be done once a year.
Throughout the year, your cash flow can fluctuate greatly, and there are a lot of variables that can affect it, so doing an annual cash flow projection doesn’t give you enough foresight. To keep tabs on your company’s cash flow, you should create monthly cash projections.
What causes cash flow problems?
There are a number of issues and bad business decisions that can negatively affect cash flow and increase business risk. Some of the most common causes of cash flow problems are:
A faulty pricing model.
Product pricing is extremely important to profits. Determine a pricing model that makes sense for your business, whether it’s value-based pricing, hourly, or project-based, and price your products and services competitively so you can generate cash coming in.
Unnecessary business spending.
If you don’t discipline your spending, your expenses can add up and reach a level that’s not sustainable for your business. Audit your expenses monthly so you know where your money is going, and cut back where possible.
Blending personal and business finances.
As a business owner, it can be too easy to mix personal and business finances. By keeping these separate, you have a clearer picture of your business cash flow (and you’re less likely to run into tax and personal liability issues).
Lack of forecasting.
It’s easy to get caught up in day-to-day operations, but it’s important to do long-term planning to maintain a healthy cash flow. By creating monthly cash projections, you can prepare for expenses and make adjustments as needed.
Growing too quickly without a plan. When your business grows, it’s exciting, but it comes with additional expenses and operating costs. Perform monthly cash flow projections, make a disciplined spending plan, and set aside a cash reserve so you’re prepared and clear on what you can afford when your business expands.
Slow-paying clients. While this isn’t always avoidable, be clear and consistent on your policies and procedures to help ensure timely payment. All invoices should have clear payment terms and expectations.
An unorganized cash flow statement. To make sure you’re organized with key accounting documents, such as your cash flow statement, it’s best to use an accounting system and keep it up to date.
Staying in the clear—the secret to effective cash flow management
To avoid cash flow issues altogether, it’s best to use proactive cash flow management strategies and tools, such as:
- Predictive analytics. Use these to intelligently forecast future cash flow.
- Regular deposits. Choose a payments provider that deposits your funds on a regualar schedule, so you always know when money from sales will arrive.
By incorporating these preemptive measures, you can take charge of your finances and work towards a healthy cash flow for your business.