50% of Small Businesses Fail because of poor Cash Flow Management!

Cash Flow Management

“Cash is king” is an adage often used to highlight the importance of cash flow management, especially for small businesses.

Statistics show that over 50% of businesses fail and, more often than not, these are profitable businesses that failed to ensure that the money coming in each month was greater than the money going out.

Believe it or not, your Cash Flow Statement is actually far more important than your Profit & Loss Statement. Your P&L will show you a dollar profit value but it doesn’t tell you how you’ve spent your money or how much cash has come in that period. Sure, your profits are important as they do ultimately increase your cash but they are not the only things that impact your cash flow. Equally, it’s not enough to just be checking your bank balance daily.

What’s the worst that could happen?

Let’s just consider the following, imagine you are running a profitable business and you decide to buy a new business asset. If you spent that money without paying attention to your cash flow and it turned out that you actually needed that for the payroll run the same week then you could be unable to pay your employees. In a small business, sometimes staff do understand that they may need to wait a day or two to get paid (though their bills still need paying) but, if this has happened before, they may well end up quitting. In a panic, to ensure your services are maintained, you then start taking up their jobs, as well as your own, putting your business at risk. In this scenario, you need to be focusing on collecting any outstanding cash owed by your customers and, at the same time, generating new business. Instead, you’re working even more hours on the wrong things. Let’s go a step further, perhaps your customers start noticing a decline in service and look to move their business away from you!  Your problems are starting to compound, you’ve lost staff, lost customers, struggling to pay your remaining staff and now there’s also critical bills that also need paying. It all too quickly becomes a downward spiral effect that is difficult, if not impossible, to break.

What does the cash flow statement show?

Your cash flow statement will show you where your money is coming from (cash inflow) and where it is being spent (cash outflow) with a focus on your bank statements and loans, unpaid customer invoices, inventory (if applicable), unpaid supplier invoices and your credit terms. The report itself is probably the most confusing to read for a small business owner but your accountant really needs to lay things out in layman’s terms for you so you can work on the key areas that will improve your cash flow.

Your business is in great shape if the cash inflow is consistently higher than the cash outflows but that shouldn’t lead to any complacency as there will inevitably be times where your outflow may be greater than your inflow. Effective, cash management ensures that these times are short lived as you will have an active plan to ensure that is the case.

 And how will that help my cash flow?

There’s a number of things that can be done to improve your cash flow situation but you’ll only properly start focusing on these when you understand what is happening and what needs to be improved.

Here’s just a couple of tips to consider:

1.    Stating the obvious, but the absolutely first step is to ensure you are issuing invoices and collecting payments promptly.

  • If you send regular monthly invoices to your customers, you can set up you accounting system to automatically create these
  • Additionally, if you are incurring expenses that you need to bill back to your customers, your accounting system should be able to mark these for you so you can easily prepare the customer invoice
  • Give customers the option to automatically pay the invoice online, e.g. Paypal, ACH payments, so checks don’t get lost in the post
  • Schedule regular reminders of payments due for your customers

2.    Paying your bills smartly.

  • Use the payment terms to its fullest so, if you have a 30-day term on a bill, use the 30 days unless your supplier offers an attractive discount option for early payment
  • Elect for automated payments either with your supplier or using the payment options within your accounting system to pay on the due date - not earlier or later

3.    Build up cash reserves

  • There’ll always be a time lag between sales and receiving payments but the dates your bills are due for payment isn’t going to change because you haven’t received money from your customers so you need to plan to have a baseline balance in your bank account to get you through those times
  • If necessary, arrange a line of credit with your bank so you have the ability to borrow money for a short period of time

4.    Introduce cash flow planning

  • Develop both short-term (weekly & monthly) and annual cash flow projections so you can manage your cash and properly plan the investments your business needs to reach your growth targets. This is even more critical if you have a seasonal business or running a project based business that receives payments only at defined milestone stages of delivery.

And the Result?

Having a strong cash flow will give you the ability to invest in the growth of your business – be it expanding to new locations, bringing on smart employees who will add to your growth potential and many others. With an excess cash flow, you can be proactive in your decision making instead of working in a reactive way discussed in the earlier example of what could go wrong.

You will be able to enjoy flexibility in decision making – you will know whether you can afford to make critical purchases in the short term as opposed to waiting, as well as being able to manage any unexpected challenges should they arise.

Having a strong cash flow will also make your business more appealing to a lender, if you need to borrow additional funds, or even to a buyer if you are considering selling your business at some time in the future.

In Summary

All accounting systems today produce Cash Flow Statements and, in large organizations these may often go un-reviewed monthly but it is critical that small businesses don’t fall into the trap. Regardless of how great your business model or what your profits are, as a business owner you need to review the Cash Flow Statement each and every month so you can make the right decisions for your business and look at also implementing cash flow planning so you can make your business everything you dreamed it would be.

 

Do you have an accurate picture of your company’s cash flow? Do you prepare periodic cash flow statements and cash flow analysis? Do you have any other tips to share that helped you?  Let me know in the comments section below.