Many small businesses struggle with cash flow and other accounting issues. There are useful tips and strategies to help you manage business finances effectively.
Many small businesses start off strong, with a solid business plan, an impressive product or service, sufficient funding to get off the ground and a growing customer base. And then somewhere along with the way, the business stalls, usually because of a cash flow problem.
Why small businesses fail
A study conducted by Jessie Hagen of the U.S. Bank found that a staggering 82% of businesses fail because of poor cash flow management or a poor understanding of cash flow. Think of cash flow as the blood running through your business's veins. When it stops, so does your business.
How do you avoid this? By monitoring your cash balance and learning how to manage it so that you always have a means of paying employees and suppliers. Cash flow management is a fundamental skill that every business owner should have.
If you've been having a hard time with accounting and cash flow management, these 12 tips can help you get a handle on your bottom line. These are hard-won lessons from a decade as a small business co-founder, president and CEO.
Anticipate and prepare
Every industry has unique periods of high and low sales. One of the first things you need to do when starting a business is to identify your industry's sales pattern. If you have this knowledge, you can anticipate weak sales periods and take steps to avoid shortfalls.
If you're just starting out and don't have a clear picture of how much you should be spending, take a look at the other businesses in your industry. Use benchmarks taken from those companies to guide your cash flow projections, but don't forget that your own inflows and outflows will still depend on the amount of cash you have.
Lower your operating costs
Cut unnecessary expenses and reduce costs where you can. Think about what you can do without (participation at certain trade shows or subscriptions to certain services) and what you can spend less on (leasing equipment instead of buying). Reducing your overhead helps increase cash flow, which means having more readily available funds every month.
How you reduce your operational costs will depend on the nature of your business, but there are certain steps most business owners can take. Looking for less-expensive suppliers, cutting back on rent and utilities by hiring remote workers, and renegotiating loan payment terms are just a few.
Ask for a deposit
Payments from customers give you access to cash to pay your bills and employees on time. If you run a service business and charge a monthly subscription fee (or bill the customer at the end of the contract), your cash flow is limited and is dependent on the timeliness of payments.
Consider having your customers pay for a deposit or a partial payment instead of billing them monthly or upon completion of a project. This way, you generate enough cash to cover your operational expenses instead of waiting for the next batch of payments so you can pay your bills. You can incentivize this by providing a discount for those who choose to pay early.
Make getting paid on time a priority
If your customers don’t pay you on time, you won't have the cash to pay your bills and other expenses. And if you don't pay your bills, you won't have a business to run. Running out of cash is not an option, which means you have to be proactive about collecting payments.
Don't hesitate to send invoice reminders. And if you want to avoid having to follow up on late payments, try to get your customers in the habit of paying early. You can do this by enforcing a late fee and by making sure that your payment terms are communicated clearly.
Make it ridiculously easy for clients to pay you
The less you wait for invoice payments from customers or for fund transfers from payment processors, the better your cash flow. To avoid late payments and expedite the invoice cycle, give your customers lots of payment options. Aside from letting them pay via cash and credit card, look into payment apps like PayPal, Stripe, Venmo, Apple Pay, and Google Pay.
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Keep an eye on your cash reserves
Many small business owners learned the value of cash reserves the hard way when COVID-19 froze economies and companies everywhere struggled to stay afloat.
Cash reserves help you through periods when business is slower than usual or when there’s a major unexpected purchase to make, such as when you have to replace an expensive piece of machinery. They get you through challenging times, like the pandemic, when business operations have to pause and there's little or no money coming in.
Experts say that a healthy savings amount is about six times your monthly operational costs.
Unfortunately, the JPMorgan Chase Institute says that half of all small businesses have cash reserves equal to less than a month's expenses. About 25% have a cash buffer equal to fewer than 13 days of expenses.
If six months seems unrealistic, aim for at least three times your basic operating costs. Make sure you put aside a portion of your profits every month, even when times are hard until you have a sufficient amount saved up.
Finance long-term assets instead of using cash
Business owners frequently make the mistake of draining their coffers to purchase major resources instead of getting financing. Even if you're not feeling the crunch right now and are confident that dipping into your cash reserves won't hurt, think about what will happen if you wind up short on cash because of a crisis or a sudden revenue shortfall.
But pay off debt as soon as possible
The sooner you pay off debt, the less you have to pay in interest and the less cash flowing out of your account every month. Try to pay off debt whenever you have a cash surplus, such as during your peak sales periods.
Regularly examine your cash flow
A key part of effective cash flow management is learning how to analyze your cash flow. Managing your cash flow means knowing when money enters your account when it leaves your account, what you can do to get cash faster, and how to control your spending to avoid issues.
Every month (or a week, if you're diligent), go through your cash flow statements to figure out how money is flowing in and out of your business. The more you do this, the more you'll learn from it. When you understand your cash flow, you're able to identify patterns and spot opportunities for increasing your income and avoiding a cash flow crunch.
Analyzing your cash flow statements should be a regular part of your routine. Accounting software like QuickBooks and Xero make it easy to do this. These tools also keep your data safe in the cloud so that you can manage your business finances wherever you are.
Cash flow management isn’t easy, but it shouldn’t be a burden either. If you're struggling to track your cash flow, or if you just don't have the patience for the nitty-gritty of accounting, hire someone to assist you. A bookkeeper can review your sales and expenses, and generate cash flow statements for your review.
Whether you do it all yourself or hire someone to do the heavy lifting, the important thing is to give cashflow management the attention it deserves.
Aside from being critical to your business's growth, effective cash flow management also frees you up to do what you do best: run your business. When you're not constantly worrying about your cash flow, you have more time to take care of your customers, explore business development opportunities, grow your team, and, ultimately, make more money.