Trying to run a business without managing cash flow is like trying to paddle a boat without an oar.
Even if you succeed, it will be an upstream exercise guaranteed to wear you out. Not to mention, poor cash flow management can result in your business shutting down completely.
With poor cash flow, it only takes one major downturn or disaster to leave you washed up.
To avoid this fate, let’s take a look at what exactly cash flow management is, and why it’s such an important part of financial management.
What is cash flow management?
Cash flow management is important for all businesses, but it’s critical for early startups. If you cannot manage your cash flow within the first year, you will likely not survive past the second year.
Poor cash flow can result in your business lacking the funds to pay suppliers or cover immediate needs.
A line of credit can only carry your business so far. Once your credit cards and loans are maxed out, you’re left needing cash or faced with the reality of shutting your doors.
Fortunately, you can perform a cash flow analysis to get an idea of whether you have positive cash flow or negative. Then you can take steps to move your business in the right direction.
To perform a cash flow analysis, you’ll need these three key elements:
- Accounts receivable: What customers and clients owe you
- Accounts payable: What you owe your suppliers
- Shortfalls: When you owe more than what you have on a liability
You must effectively manage all three if you want to navigate your business to success. An imbalance in one area, like having clients that owe you too much or you owing suppliers too much, can throw your cash flow for a loop and ultimately hurt your business.
To actually determine your current cash flow, you’ll look at how much money you have coming in, and how much you have going out. If you have numerous customers or clients that owe you money but have yet to pay, make sure you’re not considering this as part of your cash flow.
Bad debt is exactly that, bad, and it isn’t helping the amount of cash you have on hand.
10 tips for determining and managing cash flow
Managing your cash flow is important, but if you don’t have any cash to manage in the first place, you’re in trouble. Fortunately, there are steps you can take to increase your cash flow and avoid potential cash flow problems.
Here are a few tips to help you row your cash flow boat in the right direction.
1. Determine your breakeven point
You should know when your business will become profitable, not because it will affect your cash flow — because it won’t — but because it gives you an early goal to strive for and a ready-made target for projecting future cash flow. Negative cash flow and negative profits make for a grim combination.
Focus your efforts on managing your cash flow with an eye toward reaching that moment when you realize your first profits.
To determine your breakeven point, you can either do a unit-based or dollars-based breakeven analysis. Both methods involve using your fixed costs, which are costs that don’t fluctuate. These include business needs like rent or utility bills.
To determine your breakeven point using units, start with your fixed costs. Then take your revenue per item sold and subtract the variable cost for each item. Now divide your fixed cost by that number.
When determining your breakeven point with the dollars approach you first need to calculate your contribution margin.
To find this, take the price of your service or product and subtract the variable cost. Then divide your fixed costs by the contribution margin.
2. Focus on cash flow management, not profits
This may sound contradictory to tip #1, but it’s not. Use your breakeven point as a benchmark. After you reach breakeven and your business is profitable, you still need to manage your cash flow, of course.
With your breakeven point reached, you at least know your business isn’t sinking. Now, you can look at those three categories from earlier — accounts receivable, accounts payable, and shortfalls — and see if any of them look like a potential problem.
If you’re breaking even but your free cash flow is already getting tight, it’s time to do a deep dive and look for issues.
Ask yourself if you could increase cash flow by requiring that new customers put more money down, or if you need to cut back on your current expenses and make some adjustments in-house.
Being new to the breakeven point is a great period of time for making these changes, as even the smallest changes can quickly reflect in your profit margin and give you an idea of what’s impacting your business cash flow the most.
When your business is more established and your numbers are higher, it can be more difficult to determine what’s impacting your financial health, as there are more players on the board and your finances are more complex.
3. Maintain some cash reserves
You will have cash shortfalls. Your business’s very survival may depend on how you maneuver through those shortfalls. If you start with some cash in your bank account, it will be easier to focus on cash flow and you won’t stress about the shortfalls.
As a best practice, try to have enough cash reserves to last you for a three-to-six month time period.
This amount of working capital can help you in the event of a temporary market downturn, allow you to shop for a new supplier if your current one raises their prices, and so on.
4. Use a cash flow worksheet
A cash flow worksheet will help you keep tabs on your general cash flow management. With a worksheet, you can track your cash outflows and cash inflows, and make general cash flow projections.
Here’s our free cash flow template for Excel. Fill out this worksheet regularly to make sure things are going smoothly and to ensure you don’t have any ugly surprises with cash flow in the coming months.
5. Collect receivables ASAP
It’s easy for customers to take their time on payments, especially if you have language like net-30 or “due in 30 days” on your invoice.
Instead, use a “due upon receipt” approach to show that payment is due in a timely manner.
If necessary, delegate the task of keeping an eye on receivables to a trusted and persistent member of your team. This person will contact customers periodically to collect payment and generally help you with collecting receivables.
6. Encourage customers to pay up faster
If it won’t hurt your bottom line too much, offer your customers early payment discounts. Also keep credit requirements strict to avoid bad debt. Establish a written set of standards for determining who is eligible for credit.
Enforce those standards rigidly. You don’t want every customer walking in the door approved for credit.
Financial institutions have very strict standards for credit, and your business should be no different.
7. Extend payables as long as possible
In contrast to receivables, get the best deal you can on payables. Extend your payables to net-60 or net-90 if you can. This will give you a higher cash balance but will also increase your debt. Some suppliers charge late fees, however, so make sure you pay on time to avoid being penalized.
This is another reason it’s important to have a healthy cash reserve on hand. If you owe suppliers and suddenly run out of money, you’re going to damage your supplier relationship and potentially lose your best supplier. They can also withhold your next shipment, which can interrupt your entire operation.
8. Boost sales with creative incentives
Think outside the box and come up with some fun ways to drive sales. Some creative ways to quickly boost sales might include sponsoring a contest, hosting a customer appreciation event, offering referral incentives, or taking your employees on a publicity tour.
These kinds of efforts can not only drive sales, but also boost your reputation and ultimately result in more customers.
9. Designate a cash flow monitor
Assign the task of monitoring cash flow to a trustworthy employee. Have that person inform you when you reach a certain threshold — for instance, when your cash flow hits $1,000.
This person should be knowledgeable in finances, especially your company finances. If you have an accountant with the bandwidth to handle this task, they would make an ideal choice. Otherwise, again, choose someone very trustworthy and reliable.
10. Use technology to your advantage
Keep cash flow spreadsheets in the cloud on sites such as Dropbox or OneDrive so you can access them from anywhere, and use professional accounting software.
Once you start using cloud-based technology, make sure you put some best practices in place to ensure security is always priority number one.
Smooth sailing with cash flow
As long as your cash flow stays positive, your business can survive turbulent waters. Project future cash flows based on history and sound financial data, always keep your income balances and sheets up to date, and stay vigilant.
Over time, cash flow management will become just another part of financial management for your company, and it will feel like second nature.
In no time at all you’ll be sailing upstream with ease, knowing your cash flow is in check and you’ve got a pair of backup oars onboard, ready to go. Now sail forth and manage that cash like the captain you are.