Small Business Cash Flow

Written by: Nick Charveron Nick

Understanding the financial position of your business is an essential task for any small business owner. This includes keeping tabs on the status of your cash flow, which is how money moves in and out of your business. You always want a positive cash flow, meaning incoming cash flow (revenue and income) is greater than your outgoing cash flow (expenses).

Maintaining a positive cash flow is critical to your company’s long term success, as is securing investors, accurately forecasting and setting benchmarks, and being able to sustain growth. However, many small business owners cite cash flow management as one of their biggest challenges. This is due to a variety of factors, ranging from not being familiar with accounting and bookkeeping to simply not having the time to dedicate to the task.

To learn more about the importance of steady cash flow and how to effectively manage it, read our complete guide to small business cash flow. You can also use these shortcuts to get help with specific aspects:

• • What Is Cash Flow?
  • Why Positive Cash Flow Matters
  • Factors That Affect Your Business’s Cash Flow
  • How to Analyze Your Small Business’s Cash Flow
  • Addressing Small Business Cash Flow Problems
  • How to Maintain a Healthy Cash Flow
  • Is It Time to Hire Professional Bookkeeping Services?

What Is Cash Flow?

Cash flow is how money moves through your business via incoming or outgoing cash. Before we get any further into the intricacies of small business cash flow, let’s quickly define what we mean by “cash”, so that you have a clear understanding of which assets are included:

Cash is all of the available cash your business has as well as any cash equivalents, or assets that can be quickly converted into cash. Cash is referred to as either ingoing or outgoing.

1. Cash inflow, or your incoming cash, is the money coming into your business. This includes payments received from your customers for goods or services, financing including loans or credit, or payoffs from investments.
2. Cash outflow, or outgoing cash, encompasses all the money moving out of your business, including payments, purchases, and investments.

Your small business’s cash flow can either be positive or negative. What exactly does that mean?

1. Positive cash flow means that you have more than enough cash to cover your business’s expenses. You want your business to have a positive cash flow.
2. Negative cash flow means that you do not have enough cash on hand to cover your bills. This is a very dangerous position for your business to be in.

The status of cash flow can be determined as follows:

Cash Flow = Cash Available at Beg. of Period – Cash Available at End of Period

As such, accurate bookkeeping, and in turn, precise financial reporting, play a critical role in having an understanding of cash flow.

Why Positive Cash Flow Matters

Small business cash flow management can be complicated, especially for those just starting out. However, one of your main business objectives should be generating a positive cash flow because it is more or less the fuel that allows your business to continue operating.

Having a positive cash flow means that your business will be better prepared for times of economic distress, such as another recession. Small business cash flow management is critical to any entity’s success because it allows you to:

• • Make informed financial decisions
  • Improve your business model
  • Pay off debts
  • Reinvest in your business
  • Set profitable price points
  • Scale growth that you can sustain
  • Return money to shareholders
  • Plan for the sale or succession of your business

Additionally, healthy cash flow is important to investors. It is one of the factors they will consider when determining whether your company is a solid investment. Being able to secure investors will be critical to growing your business so you want to make sure your finances are in order.

If you’re not confident in your ability to keep track of your outgoing and incoming cash, that’s okay. FinancePal specializes in small business bookkeeping so you don’t have to. We’ll even provide you with financial statements for review so you always know where your business stands.

Factors That Affect Your Business’s Cash Flow

Experiencing cash flow problems at any point in your business’s operation can be more detrimental to its overall financial health than seeing losses month after month. In fact, according to a study by U.S. Bank, poor management of cash flow causes 82% of small businesses to fail.

So what factors affect your business’s cash flow? There are many, but several of the most important include:

• • Inventory – While inventory is necessary for product-centric businesses, it can become an issue if you have invested in too much inventory that is not selling quickly enough.
  • Sales – Sales are an important factor in growing your business but when it comes to cash flow, it’s not a direct indicator of your success. Additionally, sales are easily affected by the economy which can make them unreliable, presenting a risk to businesses with high expenses.
  • Accounts Receivable – This is the incoming cash you have from purchases. If you have too many open invoices, meaning you’re waiting for money to actually hit your account, it could lead to trouble.
  • Accounts Payable – This is the outgoing cash your business is responsible for. Accounts payable can include labor costs, loans, and other operational expenses.

A lot of small businesses run into cash flow issues when these factors stack up because they are trying to grow too quickly. Without proper financial planning, these aspects of your business can get out of hand.

Common Cash Flow Issues in Business

Here are some of the most common small business cash flow problems:

1. Overspending: It’s understandable that any new business owner would be excited to get their company up and running as soon as possible and make it the absolute best it can be. However, many small business owners go overboard by purchasing goods and services they don’t need or can’t afford yet.
2. Overly optimistic forecasting: In order to mitigate the risk of falling short, you want to take a conservative approach to forecasting. Optimistic forecasting can lead to overspending or poor preparation which can leave your business vulnerable to serious problems.
3. Poor bookkeeping: Whether due to lack of time and resources, or just simply not understanding core bookkeeping and accounting concepts, many business owners struggle with managing their books. However, it is critical to keeping your business’s finances up-to-date and accurate.

While cash flows are unique to each business, it is important to understand the basics and how to analyze your small business’s cash flow to improve your business’s cash flow management.

Profit vs. Cash Flow

Just because you’re profitable doesn’t mean your business is not in danger of cash flow problems. Even if you are seeing profits month-over-month on your sales, you have to wait until you actually have that income in cash for it to reflect as actual cash flow.

This brings us back to the concept of accounts receivable. If the majority of your profits are attributed to still unpaid invoices, you can’t count it toward your cash flow.

Seasonality

Depending on the type of business you run, and even your location, your cash flow may be subject to seasonality. You should factor in seasonality when trying to optimize your cash flow if:

• • Your main product or service revolves around a particular holiday or season
  • Your location has a tourist season
  • Your business is outdoors or is otherwise heavily dependent on the weather

You will need to keep these factors in mind when managing how you handle hiring, spending, operating hours, and more. Some seasonal businesses find it beneficial to only operate certain times of the year or find opportunities to expand their offerings so they are less affected by seasonality.

How to Analyze Your Small Business’s Cash Flow

To gain insight into the cash flow of your business, you need to analyze the factors that impact it. By reviewing each of these factors, you’ll be able to determine areas that are negatively impacting your business and focus your energy on improving your cash flow management by tackling those issues.

A quick way to identify a cash flow problem is to compare the upcoming expenditures you have against the total sales that will be closed out and paid for by customers. A cash flow problem will be obvious if you will owe more than you’ll have coming in. For a more in-depth analysis, you will need a statement of cash flows that will show all of your business’s transactions.

With a detailed layout of your expenses and income, you will be able to improve your small business’s cash flow management by identifying which periods may be a stretch and prepare ahead of time. You should set aside cash for slow periods or seasons where you will not be bringing in sufficient income to meet the demands of expenses.

Understanding the Statement of Cash Flows

The statement of cash flows divides cash activities into three categories:

• • Operating Activities: The cash spent to support the core activities of your business. Operating activities include the functions directly related to the selling of goods or performing your business’s services for clients, payroll, and paying your small business taxes.
  • Investing Activities: The cash spent to purchase assets and the cash generated by selling assets. Assets may include equipment and other resources needed to grow your business.
  • Financing Activities: The cash spent or earned on funding initiatives. This may include issuing stocks or taking out loans to help support your business operations.

By evaluating these three categories, you will have a better understanding of your business’s cash flow. It’s important to note that a positive sum means that there was an overall increase in cash, while a sum in parentheses denotes a decrease in cash.

Near the bottom of the statement of cash flows, you will find the overall increase or decrease of all three of these activities combined, labeled as the net increase/decrease in cash and cash equivalents. This line item will show the overall change in your small business’s cash flow during the period.

It’s important to keep two things in mind when using your statement of cash flows to make predictions and decisions about your business:

1. Historical data is useful, but it’s not a perfect indicator of what to expect in the future.
2. It only presents one part of your business’s finances. To get a full scope of how your business is doing, you should refer to your other financial documents as well.
3. The data in the statement of cash flows is only as good as the bookkeeping you used to generate your financial documents.

That being said, it is a useful tool you can use to help you determine whether you have the cash on hand to pay your expenses.

Addressing Small Business Cash Flow Problems

Cash flow issues in business aren’t necessarily tied to businesses of certain sizes, but smaller businesses can lack the resources for adequate financial management, especially in the first few years. As such, many small businesses are affected more drastically.

However, you can prevent your business from becoming a statistic by taking action to address cash flow problems—or even avoid them completely—with these top five small business cash flow management tips:

1. Stay on top of bookkeeping. If you’re handling all aspects of your business on your own, it can be difficult to stay on top of continuous bookkeeping. However, maintaining accurate records of bills and invoicing can cause you to fall behind on payments and collections from customers, ultimately putting your business in a bad position.
2. Reduce overhead expenses. The overhead expenses, or cost of running your business (rent, utilities, etc.), could be too high for you to maintain positive cash flow. If this is the case, you may be able to reduce costs by downsizing your office or finding a storefront in a less expensive neighborhood. Regularly auditing your expenses is a safe way to monitor your overhead and identify where budget cuts can be made.
3. Set credit terms. Instead of allowing customers to pay for merchandise whenever they please, you can protect your business by setting terms around payment deadlines. This can help you establish a more reliable stream of incoming cash. However, this isn’t a one-and-done solution. There may be instances where clients do not pay you on time, or in a worst-case scenario, at all. Another alternative is offering some kind of discount for clients who pay all or a portion of the invoice up-front such as a cash discount. This way, you can improve your incoming cash flow quickly.
4. Closely manage inventory quantities. Whether you’re the one manufacturing the goods or you are distributing those provided by another business, you want to try to avoid stocking up on excess inventory. However, you also don’t want to constantly be out-of-stock, especially on your most popular products. Achieving the right inventory balance will require some analysis on your end to figure out how much of each product you should keep in stock.
5. Improve profit margins. If you aren’t making a decent profit on your products or services, this could be hurting your business and preventing growth. You should make sure that all costs are accounted for in your pricing. If certain products or services are not yielding good profit margins, it might benefit you to cut them from your business.

Implementing all five of these initiatives can help you turn your cash flow around.

Short-Term Financing Solutions

If you’ve found that your cash flow situation does not look like it is going to turn around quickly, you may want to consider financing options. Securing financing can help you turn your cash flow positive almost immediately.

There are many different types of small business loans; if you are considering a loan to help with cash flow issues, shop around for the best loan terms you can find. You’d be surprised what a big difference lower interest rates can make.

However, it is important to keep in mind that you will have to pay off the loan or credit, plus interest. While financing isn’t the ideal way to resolve cash flow issues in your business, it may be your only option to keep your business afloat.

How to Maintain a Healthy Cash Flow

Even once you’ve corrected course and achieved positive cash flow, you shouldn’t let it fall off your radar. In order to maintain a healthy cash flow, you should:

• • Monitor your cash flow on a regular basis. As with your other financial statements, you should review your statement of cash flows every period.
  • Open a line of credit for emergencies. Securing a line of credit to have in your back pocket in case of cash flow issues can help you improve your cash flow quickly. If you get a credit card with good terms and rewards, you could also use it to cover certain expenses in your slow seasons to offset lower-than-usual incoming cash.
  • Require partial payment up front. While setting terms for your clients is one way to improve payment turn-around, you can also require deposits or partial payments for larger orders up front to reduce accounts receivable.

The key to good business cash flow management is taking a proactive approach. That way, you can protect your company’s livelihood instead of scrambling to find a way to restore it.

Managing the day-to-day aspects of your business on top of finances and taxes can be draining and lead to mistakes you simply cannot afford. If managing your small business cash flow seems like too much to handle, let the experts at FinancePal take over these responsibilities.

General Rules for Healthy Cash Flow

In general, there are few rules that every business owner should keep in mind to help maintain healthy cash flow:

• • Focus on cash flow first, not profits
  • Expenses should never exceed existing cash
  • Maintain your cash reserves to help offset shortfalls
  • The more quickly you want to grow, the more cash you need
  • Carefully consider any investments
  • Don’t go overboard in stocking inventory
  • Do not take on large amounts of debt that you cannot afford in the long-term

Growing your business takes sufficient available cash. As such, maintaining a healthy cash flow should be one of your top objectives.

Is It Time to Hire Professional Bookkeeping Services?

Knowing when to seek professional help for your business finances can be the difference between success and failure. If the growing demands of your business have made it difficult to keep up with your bookkeeping, or you do not want to be responsible for this aspect of your business, you’d likely benefit from professional small business bookkeeping services.

Using FinancePal, you can streamline your accounting and bookkeeping and enjoy the peace of mind that we will be monitoring your business’s financial position in extensive detail. Our experts can keep an eye on your cash flow and help you take a more proactive approach to small business cash flow management.

In addition to helping you maintain healthy cash flow, we can assist you with other important aspects of your business’s finances, including how to set up payroll and handling your freelance taxes. Whatever your needs, your dedicated financial team will be one of your biggest resources to ensure that your business thrives.

About the Author

Jacob Dayan, Esq.

Jacob Dayan is a true Chicagoan, born and raised in the Windy City. After starting his career as a financial analyst in New York City, Jacob returned to Chicago and co-founded FinancePal in 2015. He graduated Magna Cum Laude from Mitchell Hamline School of Law, and is a licensed attorney in Illinois.

Jacob has crafted articles covering a variety of tax and finance topics, including resolution strategy, financial planning, and more. He has been featured in an array of publications, including Accounting Web, Yahoo, and Business2Community.

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About the Author

Nick Charveron, EA

Nick Charveron is a licensed tax practitioner, Co-Founder & Partner of Community Tax, LLC. His Enrolled Agent designation is the highest tax credential offered by the U.S Department of Treasury, providing unrestricted practice rights before the IRS.

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About the Author

Jason Gabbard, Founder and CEO of JUSTLAW

Jason Gabbard is a lawyer and the founder of JUSTLAW.

About the Author

Andrew Jordan, Chief Operations Officer at FinancePal

Andrew is an experienced CPA and has extensive executive leadership experience.