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Cash flow is the lifeblood of a business. To keep it operating smoothly, it’s essential to ensure you have more money coming in than going out.
While effective cash flow management is fundamental to a business’ success, it’s not uncommon for business owners to struggle with cash flow problems. Understanding cash flow basics, such as planning and cash flow statement analysis, can help you run a business with long-term financial sustainability.
In fact, according to data from the Bureau of Labor Statistics (BLS), around 20% of small businesses fail within the first year, and 65% fail by the tenth year. Cash flow management is a common reason for these failures.
In other words, you’re not alone if you’re worried about cash flow. But if you learn more about cash flow forecasting and use cash flow management software, you’re on track to run a durable business with long-term staying power.
To help you manage cash flow effectively, we’ve compiled tips on ensuring your business’s financial health.
What is cash flow management?
Let’s start with the definition of cash flow management. Cash flow management refers to tracking money as it moves in and out of your business. By tracking these funds, you can forecast how much money will be available to your business.
To help you manage your cash flow, it’s critical to reference your cash flow statement, which reports the cash generated and spent during a specific accounting period. Cash flow includes all parts of your business, such as operations, investing, and financing.
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 or late employee paydays.
To avoid this, you should carefully manage your cash flow each month and focus on creating a positive cash flow, meaning more money enters your company than leaves 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.
Cash flow statements 101
A cash flow statement is a crucial financial tool that shows how cash moves in and out of your business over a specific period. It tracks cash inflows like sales or loans and outflows like rent, payroll, and inventory. Unlike a profit and loss statement, it focuses solely on actual cash, giving you a clear picture of liquidity.
Traditionally, cash flow statements have three sections: operations, investments, and financing. For example, if your business takes on new debt you plan to use (for things such as equipment, business expansion, etc.), you would likely have a positive cash flow in the financing section. When you repay the debt, there is a negative cash flow in the financing section.
This statement helps monitor your business’s financial health by identifying trends and potential cash shortfalls. For instance, it can reveal seasonal fluctuations or periods where expenses outweigh revenue. You can take proactive steps to maintain stability by spotting these patterns early.
Your cash flow statements are one of the most important tools for tracking cash flow for your small business. Square also offers helpful reports to help you better understand your cash flow.
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 revenue represents money coming into the business, it doesn’t represent the cash generated by the company. Even when you have a profitable month, those funds aren’t always available immediately, so it doesn’t necessarily translate to a positive cash flow.
- We have strong accounts receivable, so we don’t have to worry about cash flow. Similar to profits, accounts receivable do not equal cash. They’re promises from customers to pay money owed in the future.
- Cash flow management is too complex for my small business. Regardless of your business size, monitoring your cash flow is necessary. Cash flow can be even more important for small business owners, as their margins may be tighter, with less of a buffer for unexpected costs.
- Cash flow planning can be done once a year. Your cash flow can fluctuate greatly throughout the year, and many variables can affect it, so an annual cash flow projection doesn’t give you enough foresight. It typically helps to create monthly cash projections to keep tabs on your company’s cash flow.
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 critical to profitability. Determine a pricing model that makes sense for your business, whether value-based, 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 maintain spending discipline, your expenses can add up and reach a level that’s not sustainable for your business. Review 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’s easy to mix personal and business finances, but that’s a huge financial mistake. By keeping these separate, you have a clearer picture of your business cash flow and are 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 adjust as needed.
- Growing too quickly without a plan: When your business grows, it’s exciting but 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: How is a cash flow statement organized? You should understand what’s on your cash flow statement and keep it organized in a way that is easy to digest regularly. Using an accounting system that’s updated with your latest financial data is best. With modern accounting software, which generally includes cash flow manager features, you can generate cash flow statements with a few clicks.
Consistently negative cash flows can lead a business into a situation where it can’t pay the bills and ultimately must file for bankruptcy. Check out our cash flow management template for an example you can use for your small business to identify and avoid cash flow problems.
Final tips to improve your cash flow
To avoid cash flow issues altogether, it’s best to use proactive cash flow management strategies and tools:
- Predictive analytics: Use these to intelligently forecast future cash flow.
- Same-day transfers: Schedule a same-day money transfer at the close of each business day so you get cash in the bank as quickly as possible.
- Instant transfers: You can use instant transfers for an immediate bank transfer. Whether late at night or over the weekend, instant transfers allow you to transfer your sales to a linked account in seconds.
- Cash flow loan: If you have a business that experiences seasonal swings, you can take out a short-term business loan to ease cash flow concerns.
- Square Debit Card: If you accept Square payments, you can manage your business funds using the Square Debit Card, a customizable business debit card. Square Debit Card gives you real-time access to your Square balance so you can purchase inventory, supplies, or anything else you need to run your business as soon as you make a sale.
By incorporating these preemptive measures, you can take charge of your finances and guarantee a healthy cash flow for your business.
