Improve Your Small Business Cash Flow with These 10 Tips

One of the biggest challenges for many small business owners, particularly in the initial and growth stage, is ensuring that they maintain sufficient cash flow.  Many businesses with great potential have suffered an untimely demise due to their inability to pay their suppliers, employees and revenue agencies.   In many cases, this can be prevented through a better understanding of your small business’ cash flow requirements and making sure that you implement relevant processes that can handle cash flow issues as they arise.

---

---

What is the difference between cash flow and profitability?

Cash flow is the amount of cash (balance in your business bank accounts + cash on hand) that a business generates, while profit is amount by which sales exceeds your expenses. Business owners often refer to cash flow and profitability interchangeably. While there is certainly a strong correlation between the two there are numerous reasons why a business might be profitable but have a negative cash flow and vice versa.  In fact, it is quite common for large publicly listed companies to be profitable but have significant cash flow deficits.     

There are many reasons why net profit is different from your cash flow, some examples of which are below:

• Customers who have time to pay after being invoiced i.e. accounts receivable. These sales are shown on your profit and loss statement (P&L) as income, but you have not yet received the cash for them.

• Purchases of machinery, computers and other physical items that are reflected as assets on the balance sheet. This means that, except for depreciation, they do not appear as expenses on the P&L and therefore do not reduce profit. They do however cost money to purchase and therefore reduce your available cash.

• You might have various bills from suppliers that you only pay a couple of months after the bill date. Similar to accounts receivable, the bill is reflected as an expense based on the date on the bill which reduces your profit. However, cash flow is only impacted when you pay the bill.

• Business loans will increase your cash flow but will have no impact on profit.

What steps can you take to improve your cash flow?

1.       Keep your Accounting Up to Date:

If you have a business where monitoring your cash flow is important, it is essential that a) you have a good accounting system and b) you keep it as current as possible. Any good accounting software will be able to provide you with your cash flow position but this is only as good as the data that goes into it.  The goods news is that it isn’t that difficult to have a good accounting system. Many small business owners in the early stages might be able to take care of their own accounting and there are an unprecedented number of cloud based accounting software and add-ons that greatly simplify the process. Alternatively, there are a plethora of firms that will handle the whole process for you at a reasonable cost depending on the complexity of your business and volume of transactions.

2.       Manage your Accounts Receivable:

One of the most important ways to improve cash flow is to ensure that you manage how long you give your customers to pay and that you ensure that they pay on time. Customers, many of whom are experiencing their own cash flow issues, will try and defer payment for as long as they can.  It is important to clarify your payment terms and follow up with late invoices as regularly as possible.  Also, keeping invoice payments up to date in your accounting system will allow you to generate an accounts receivable listing that makes following up with customers easier. Many accounting software, such as Quickbooks Online, allow you to generate and send statements to your customers.

3.       Offer Discounts and Expand Payment Options:

Incentives for early payment can be a powerful way to reduce the collection time for your accounts receivable.  Similarly, allowing customers different payment options including e-transfers and credit cards makes it more likely that they will pay on time.  The good news is that there are numerous payment processors that allow small businesses to accept direct and credit card payments.   Keep in mind that there are fees associated with all of these options so it is a good idea to research the different options for small business payments from customers.

4.       Manage Inventory:

While it is important for businesses to be able to meet their customer demands quickly, there is a cost to having too much inventory on hand.  In addition to it restricting cash flow, there are storage and maintenance costs as well as the possibility that it may lose value as new models replace old ones.  It is important that you regularly assess your inventory on hand with a view to optimizing it.  There are software to help you with that decision and if your inventory is complex, it may be worth investing in a system that allows you to scan and track your inventory in real time.

5.       Take advantage of Supplier Discounts:

 Suppliers, likewise, are usually eager to collect on their receivables as soon as possible.  To this end, many of them offer discounts for early payment which should be taken advantage of to the extent that your cash flow permits.  When cash flow is tight, you can usually ask your supplier to extend the due date of bills which can give you some breathing room. They might charge an additional administrative fee, but it can be worth it to ensure that you have enough cash on hand to meet your other obligations.

6.       Raise your prices

Every business owner needs to examine their prices regularly to ensure that they are covering their costs and are on track to make a profit. It is common in the early stages of starting a business to not have enough data for optimal pricing. In fact, many businesses will offer a discounted price early on to bring in customers and validate their product. However, once a business has achieved a certain amount of traction, there is room to increase prices which is the most direct way to improving your bottom line.

7.       Review existing contracts and reduce expenses: 

Perhaps the most obvious way for a small business to improve their cash flow and profitability is to cut costs.   Every business incurs a variety of expenses, which accumulate over time. It is good practice to have a system to monitor your expenses periodically to ensure that you are still using them and they are adding value to your business . Most businesses have an ever increasing amount of monthly subscriptions (which has become a popular business model) including monthly phone or internet costs .  Many service providers are open to negotiation, as they want to hold on to their customers, particularly when the service they are offering has many competitors. Alternatively, you can simply seek out these competitors, who are happy to bring you on board and may offer you a reduced price.

8.       Reduce or defer owner salaries: 

While small business owners need to draw a salary to cover their living expenses, one of the simplest ways to free up cash flow in the short term is to reduce or forego your salary .  Keep in mind that owners salaries are a basic and essential cost of the business so, depending on the tax consequences, it makes sense to still pay yourself a salary and then reinvest it into the business to cover any cash flow shortfalls. Ideally, this is only a temporary measure.

9.       Set up a line of credit:

One of the best things you can do when starting your business is to set up a line of credit with your bank. While a new business might have trouble getting a line of credit immediately without a personal or other type of guarantee, it is still a good idea to initiate the process while you build up credit or give a guarantee, if necessary.  A line of credit is usually better than a loan as you are only paying interest on the amount that you withdraw when needed, while a loan is usually given as a lumpsum payment for which you pay interest on the full amount. It also gives you greater flexibility to make repayments compared with a loan which usually has fixed payment terms and often penalties for early repayment.

10.   Prepare a monthly (or even weekly) budget : 

Estimating your revenues and expenses and the associated cash flow (you might sell $100k this month but only receive it in three months) is one of the primary tools to help small business owners clearly understand how much they need and how much they can spend.  This can be set up as a spreadsheet (numerous templates are available online) or via budgeting software.  Budgets don’t have to be overly sophisticated or even exact – they are really just estimates that allow you to determine the timing of cash flows.  It is important to update it regularly as circumstances change.

Managing your cash flow can be challenging, particularly when your business is growing.  It can be frustrating to know that despite having a profitable business, you find yourself having to scramble for cash flow and/or extended credit.  This is largely due to business cycles where payments from customers are often received after existing orders have to be funded.  As such it is important to have (even informal) processes in place to deal with these issues as they arise. 

Ronika Khanna is an accounting and finance professional who helps small businesses achieve their financial goals. She is the author of several books for small businesses and also provides financial consulting services.

Subscribe to our biweekly newsletter to receive articles, tips, tools and special offers for small businesses.