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.
Cash flow problems occur when a business doesn’t have enough money to cover its liabilities. When this happens, businesses often struggle to make payroll, pay down debt, and finance their expenses.
These problems can lead to decreased credit ratings, low employee morale and missed opportunities to grow the business. If your business is struggling with poor cash flow management, there are several steps you can take to fix it.
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Why small businesses fail
A study conducted by Jessie Hagen at U.S. Bank found that a staggering 82 percent of businesses fail because of poor cash flow management, as reported by The Hartford. 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? Monitor your cash balance and learn how to manage it so 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, the following 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.
Accounting and cash flow management lessons
1. 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 identify your industry’s sales pattern. Once you have this knowledge, you can anticipate weak sales periods and take steps to avoid shortfalls.
If you regularly deal with slow seasons in your business, consider diversifying your products and services to attract a wider range of customers. You can also offer promotional sales and discounts to drive more sales during slow periods.
2. Set benchmarks.
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 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.
3. Lower your operating costs.
Cut unnecessary expenses and reduce costs where you can. Think about what you can do without (e.g., participation at certain trade shows or subscriptions to certain services) and what you can spend less on (e.g., leasing equipment instead of buying). Reducing your overhead helps increase cash flow, which means you’ll have more readily available funds every month.
The best way to 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 ways to save.
4. Ask for a deposit.
Payments from customers give you cash to pay your bills and employees on time. If you run a service-based business and charge a monthly subscription fee (or bill the customer at the end of the contract), that can mean your cash flow is limited and depends on the timeliness of payments.
Consider having your customers make 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 encourage your customers to do this by offering early payment discounts.
5. Make getting paid on time a priority.
If your customers don’t pay you on time, you won’t have the cash needed 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. If you want to avoid needing to follow up on late payments, try to get your customers in the habit of paying early. Make sure you communicate payment terms clearly, and enforce a late fee.
6. 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. [See our PayPal review and Stripe review]
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7. 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 need 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 percent have a cash buffer equal to fewer than 13 days of expenses.
If six months of savings seems unrealistic, aim for at least three times your basic operating costs. Put aside a portion of your profits every month, even when times are hard, until you have a sufficient amount saved up.
8. 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.
9. Pay off debt as soon as possible.
The sooner you pay off debt, the less you 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.
10. 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 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’ll be able to identify patterns and spot opportunities for increasing your income and avoiding a cash flow crunch.
11. Automate your statements.
Analyzing your cash flow statements should be a regular part of your routine. Accounting software like QuickBooks and Xero make this easy to do. These tools also keep your data safe in the cloud so that you can manage your business finances wherever you are.
If you’re looking for the right accounting software for your business, check out our best accounting and invoice-generating software picks for 2023.
12. Get help keeping track.
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 you to look over.
Whether you do all the heavy lifting yourself or hire someone to do it for you, give your cash flow management the attention it deserves.
Positive cash flow leads to better business
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.
Jamie Johnson contributed to this article.