How to Improve Your Small Business’s Cash Flow

What is cash flow?

Cash flow refers to the intake and output of money within a business. It encompasses all the revenues and expenses of a company at a given moment in time. Cash flow management is planning your inflows and outflows accordingly to ensure your business always has cash reserves. The best accounting software can help business owners keep track of their cash flow and other financial metrics. [Learn more about accounting and cash flow management from a CEO.]    

What are common cash flow problems and how to solve them?

Poor cash flow management is one of the top reasons small businesses fail. 

“Problems with cash flow can quickly turn into big problems for small businesses,” said Mark Hirsch, an attorney and founding partner of Prime Time Business Network. “How well these problems are dealt with determines long-term progress.”

Properly managing your cash flow takes time and energy, but it’s imperative to understand where and when your cash is coming in and how it’s leaving. As you monitor your finances, be aware of these common cash flow problems that can severely impact your business.

1. Late client payments

Late payments are one of the leading causes of cash flow problems for small businesses. Small business owners typically operate with tight budgets and rely on receiving customer payments on time to pay bills and scale. Unfortunately, many clients pay late, some taking well over the standard 30 days to pay what they owe. Waiting over two months for payment can put your business in financial danger, especially when you rely on cash for growth. You may even need to spend time and money getting outside assistance to help with nonpaying customers.

How to solve this problem: A great way to avoid having to deal with late payments is to get up to speed on the best billing practices. Using cloud-based online invoicing software for all your billing needs is a good start. In addition, many online payment solutions provide invoicing tools to help customers pay you on time. These allow your business to accept multiple payment forms, automatically follow up with clients and easily access your invoice records and reports. Hirsch also suggested rewarding clients who pay early. 

“A 2 percent discount for payments made within 10 days can help flow cash faster,” he said. 

If you need help with your invoices, check out our review of FreshBooks, a leading accounting software platform useful for creating and managing invoices. You may also want to consider charging late fees and interest for nonpayment to encourage customers to meet their obligations in a timely manner. 

2. Lack of profitability

Lack of profit is another common reason companies fail. Yet, while there is a correlation between poor profitability and cash flow problems, financial issues can also arise for businesses that are making a steady profit. If your organization has high business expenses and you’re looking to reinvest profits, you need to be extra mindful of cash flow issues. Plenty of companies have gone under, despite raising millions of dollars, owing to the simple fact that they were unable to generate steady cash.

How to solve this problem: The best method to avoid profitability issues is to always look for more profit-making opportunities that expand your revenue sources and increase cash flow. These include developing new products or services, implementing product markups, doing consulting work and offering discounts and deals to increase traffic to your business.

3. Withheld investment or funds

Locking in an investment or loan to fund your business is always great for capital. However, doing so has some rather severe contingencies. For example, an investor or bank can withhold a portion of your funds if you don’t meet expectations or your income is much less than you projected. This can cause cash flow issues if you rely on those funds to cover major expenses, such as replacing broken equipment or responding to an emergency situation.

How to solve this problem: The best way to avoid investors withholding funds is to give yourself breathing room. When you initially ask for a loan or seek an investment, ask for 25 percent more than “projected” as a line of credit. This way, you have extra cash available for an unforeseen emergency. [See our picks for the top business loan and financing options.]

4. Tax filing

Whether you’re a monthly, quarterly or annual tax filer, it’s your responsibility to file the correct amount of business taxes on time. Tax filing itself isn’t a cash flow issue, but failing to file correctly or promptly can cause detrimental cash flow problems for your business, including interest payments, penalties and even an audit from the IRS. These consequences are expensive and take up valuable time.

How to solve this problem: The best way to avoid these issues is to stay ahead of tax deadlines and consult a tax specialist. Most business owners are busy enough as it is, so it’s a good idea to delegate tax work to a professional. A tax specialist can help you prepare and file your taxes on time and uncover potential tax deductions.

When tax time comes around, make sure you have enough cash in the bank to pay what you owe. While you may not know for sure the exact dollar amount you’ll need to pay ahead of time, you can build a basic model based on last year’s taxes versus your growth for the current year.

5. Undervalued products or services

As a business owner, you need to understand the value of your product or service and set your pricing accordingly. You might worry that raising prices will turn people away, but that isn’t necessarily true. Increasing the cost of your product or service also increases its perceived value, which could bring in more customers. Conversely, if your prices are too low, people may perceive your product as less valuable or of lower quality. However, setting your prices too high means you could lose out to competitors offering better rates.

How to solve this problem: To maximize your profit, find a happy medium. Price your services high enough to increase your cash flow and establish your business as valuable, but not so high that you jeopardize potential sales. Conduct market research to help determine the best price points for your company and target audience.

6. Scope creep

“Scope creep” is when a project’s requirements unexpectedly change or increase over time. It’s an all-too-common phenomenon that isn’t necessarily bad, but you’ll want to be aware of it and manage it appropriately with clients. This can ensure you’re being compensated fairly for your work and prevent you from incurring additional costs that impact your cash flow.

How to solve this problem: Determine what is expected of you at the outset of any client project you undertake. If those expectations change, seek compensation for your time and associated costs. Failure to do so means you’re not only being paid less for the work you’ve completed, but your costs could also increase, compromising your cash flow.

>> FREE TOOL: Cash Flow Calculator

7. Use of old equipment

Old equipment not only takes up valuable space but is also inefficient. Constantly replacing equipment can be costly and frustrating, especially as technological advances render older product models obsolete. Outdated, poorly functioning equipment often means not getting the best bang for your buck, so to speak, and may subtract from your bottom line instead of adding to it.

How to solve this problem: Keeping up with the newest equipment will help your business run optimally. Leasing your devices and machinery can be a cost-effective method of ensuring you always have the latest and most efficient technology at your fingertips. In some cases, selling old equipment can also result in taxable gains.

8. Debt payments

Carrying too much debt is a major financial burden for all types of businesses. You may have liabilities from loans, credit card usage, leases, operational costs and more. Anything your business owes is considered debt. Owners are often forced to declare bankruptcy when their cash flows are insufficient to meet ongoing debt payments.  

How to solve this problem: Make sure you always maintain a healthy level of business debt. If your debt burden becomes too heavy to manage, consider taking steps such as debt consolidation to lower your monthly payments and increase cash flow. Hirsch advises small business owners to take out a business line of credit that they can use during tough times instead of relying on high-interest loans. 

9. Poor inventory management

Turning over inventory quickly can generate a higher return on investment for your business. Conversely, slow-moving or overstock can bog down your returns. Excess inventory ties up your capital, reduces cash flow and prevents you from restocking with a more appropriate product assortment. 

How to solve this problem: Many accounting software programs offer inventory and sales forecasting tools to help you manage physical products. If you end up finding yourself stuck with overstock, consider solutions for cashing in on excess inventory, such as unloading it in bulk through a liquidation marketplace. You might also look into obtaining a merchant cash advance or working capital loan. 

10. Improper accounting

Poor internal controls and inconsistent accounting practices prevent business owners from maintaining a firm grasp on when cash is coming in and out. As a result, they may be unaware of growing financial headaches.

“Businesses often lack a clear understanding of their current cash flow situation,” said Shishir Khadha, an accountant and the creator of Cashflowpedia. “There is often no process in place to establish monthly or quarterly cash closing balance targets … [or] for preparing cash flow statements and forecasts to measure key metrics and KPIs.”

How to solve this problem: High-quality accounting software makes it easy to stay on top of your business’s finances with logs and reports for a range of financial metrics. Expenses are automatically recorded into your business’s ledger, and you can quickly and easily prepare financial statements. With proper accounting and modern, cloud-based software, you can track cash flow with ease and uncover any shortfalls before it’s too late.

Why is cash flow important?

Cash flow is important and essential because businesses cannot pay wages and bills on time without liquid capital. Not having enough cash on hand also means delaying any equipment purchases or new acquisitions. In some cases, a lack of liquid cash can lead businesses to expensive financing options that leave them in debt, increasing expenses in the form of debt service.

Having money in the bank is critical. A profitable but cash-poor business could ultimately run into significant issues that cut into profit margins or, worse yet, eclipse profitability altogether. Likewise, poor cash flow management leads to bigger issues for a business that, if left unaddressed, can rapidly snowball into a massive problem.

Managing cash flow can be stressful regardless of the size of your business. However, solving your cash flow issues doesn’t have to be complicated. You’re on the right track if you take the necessary precautions and remain educated on your company’s specific cash flow needs. Keep the above-mentioned cash flow problems and their solutions in mind to help you avoid and mitigate such issues for your enterprise.

Mike Berner contributed to this article.