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How to manage small business cash flow

Tuesday, August 29, 2023

This might sound familiar: As hard as you try to turn a profit, the expenses seem to pile up on your desk even faster. You do your best to grow your customer base and make more sales, but at the same time, customers are late on their payments, you can never get your inventory just right and those interest rates on your business credit card keep stacking up.

No matter what you do, there just never seems to be enough cash on hand.

We get it. Figuring out how to gain control over your business finances is one of the most difficult parts of running a business. And managing cash flow is a big part of that.

Even if your small business tends to operate on a leaner budget, with proper cash flow management techniques you can free your money and sleep easy knowing your overall business health is in a good place.

In this article, we’ll go over everything you need to know to manage your cash flow with confidence:

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Cash flow 101

What is cash flow?

To understand cash flow, there are a few terms we need to clear up first. Here’s a brief dictionary of the keywords we’ll be talking about.

Cash: All the money that belongs to your business, whether in a safe at your office or in your business checking or savings bank account.

Cash equivalents (CCE): Money you can quickly convert into cash — like treasury bills, notes or money market funds.

Cash flow: The movement of cash and CCEs coming into and out of your business.

Cash inflows: Money coming into your business from sales of goods and services, or from a business loan or investment.

Cash outflows: Money leaving your business due to business expenses like business-related purchases, taxes, rent and payroll.

Why is cash flow management important to small businesses?

If you want to stay in control of your business, you need to stay on top of your cash flow. By making sure your money is free to move, you’ll have cash when you need it to put toward opening new locations, attracting more customers or whatever your next big idea may be. Plus, it’ll make you look more attractive to lenders if you require a larger sum of funds to fuel your business’ growth.

The goal is to get to positive cash flow — aka to make more money than you spend. Your cash flow statement is your secret weapon to achieve just that.

Wondering what a cash flow statement is? It’s a financial statement that shows the difference between the amount of cash coming in and going out of your business. Another way to look at it is a measurement of how much money your business generates versus how much it spends.

Here are a few reasons using your cash flow statement to keep your finger on the pulse of your business’ finances is vital.

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Keeping an eye on your cash flow statement and cash flow forecast will paint the most accurate picture of your business’ finances. Since it’s a more frequent calculation than a profit and loss (P&L) statement (the document that reveals your net profit), it gives you a more up-to-date view of how money is moving throughout your business and shows you the “why” behind the numbers you’re seeing on your P&L.

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Having a handle on your cash flow helps you make better business decisions, especially when planning for new opportunities. You can match up the cost of a new business opportunity with your cash flow projection to find out fast whether or not you can afford to put some of your free cash to work.

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The more positive your cash flow, the more financially healthy your business will be. With positive cash flow, you’ll be able to pay your business expenses and staff on time, ultimately boosting your reputation, bottom line and long-term stability.

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Positive cash flow also means having more money on hand to put toward expanding your business. That could mean either using the extra capital to grow your business yourself or using the free cash to demonstrate to potential investors that you have a healthy business model.

Tracking and managing cash flow

So, you understand the importance of using your cash flow statement to track your money and assess your financial health. But how do you navigate the ins and outs of your statement? Let’s break it down.

There are three sections in a basic cash flow statement that cover different cash flow categories:

Operating activities

Cash inflows and outflows directly related to running your business, including short-term investments, sales, payments, rent, utilities and taxes.

Investing activities

Cash inflows and outflows, including any equipment purchases or sales, new business acquisitions, property purchases or sales, stock purchases or sales and other fixed-asset purchases or sales.

Financing activities

Cash inflows and outflows related to any financing costs, including loans (proceeds or repayments), credit card debts, capital lease payments, dividends paid or received and employee stock options or purchases.

Next, there are two ways to calculate your business’ cash flow: direct and indirect. Since the majority of small business owners rely on the cash-basis method of accounting (only recognizing cash when it’s received, not when it’s earned), we’ll focus on the direct method. It’s a fairly straightforward calculation: Simply add up all of your inflows and subtract all of your outflows from each section of your statement to find your total cash flow number. Not a math fan? Your bookkeeper or accounting software can help.

As we mentioned before, if your business brings in more cash than it sends out, you have positive cash flow. This is what you’re shooting for. The more positive cash flow you have, the more working capital you have (that’s assets you can quickly put to work). And the more working capital you have, the healthier and more stable your business will be.

On the other hand, if you spend more cash than you bring in, you have negative cash flow. A word of caution: Cash flow problems can snowball quickly if you don’t nip them in the bud. Let’s get into cash flow management best practices to help you avoid issues from the start.

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8 tips for managing cash flow

OK, you know why managing cash flow is crucial and how to use your cash flow statement to calculate your status. But there are more pieces to the puzzle if you want to maximize your money. Here are some actions you can take to optimize your business for positive cash flow.

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1. Know your cash conversion cycle

Never heard of a cash conversion cycle before? It’s the time it takes for you to buy the materials your business needs, turn those materials into products and sell them. While some businesses have fast cycles, others may have more stagnant ones.

Knowing the number of days your cash conversion cycle takes can help you forecast how much of your money will be tied up at any given period of time. The logic goes: The faster the cash conversion cycle, the less your cash will be absorbed in making goods — and the more your cash will be free to move.

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2. Find your break-even point

Your break-even point is when your revenue over a certain period of time covers all your expenses. In other words, your total cash inflow equals your total cash outflow.

Not knowing your break-even point is like running your business blindfolded. Whether deciding when to cut costs, increase pricing or target a broader customer base, your break-even point can provide insight into how to make informed decisions, run a better business and negate cash flow issues before they can gain a foothold.

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3. Revisit your accounts receivable policies

Getting paid on time is a big part of ensuring your business has the positive cash flow it needs. But we know what you’re probably thinking: Getting customers to hit payment deadlines is easier said than done. The first step in bumping up your likelihood of getting paid is setting a policy around your accounts receivable or payments, credits and collections customers owe your business.

Depending on your industry, your payment terms look different. In some cases, those terms can involve upfront deposits or recurring payments. Other times, you might want to extend a line of credit to your customers or implement a delayed payment agreement. No matter how you set up your policies, the key is to communicate them to your customers and ensure they understand the terms.

Everyone has trouble at times remembering the million tiny to-do’s following them from day to day — including your customers. For a better cash conversion cycle, it’s a good idea to send automated reminders to your customers when payments are due or overdue. For an extra incentive, you can even offer customers early payment discounts. The bottom line? Minimizing the amount of late payments means minimizing the amount of time you have to make do with shallower cash reserves than you planned for.

Pro tip

Electronic billing and invoicing solutions are the best way to automate this part of your business. Not only can sending online invoices help you get paid more quickly, but offering an electronic payment portal also provides convenience for your customers, allowing them to pay by debit, credit card or ACH in a matter of seconds instead of having to rely on paper checks and snail mail. An extra plus? It’s also better for the environment.

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4. Double-check your accounts payable policies

While accounts receivable is money owed to you, accounts payable is money your business owes to others, like creditors and suppliers. We’re often taught that speed is something to strive for. If you turn in an assignment early, you get a gold star. Right? Well, not always.

Although you may feel the urge to pay bills off as soon as you get them, it’s a smarter move to hold onto your money as long as possible. We want to be clear: This doesn’t mean making late payments. But it does mean ensuring your bookkeeper knows you do not wish to pay bills early. Delaying payments to vendors and lenders until the due date helps ensure you have enough cash on hand each month.

It’s also a good idea to negotiate flexible payment terms or other incentives for your accounts payable. The more flexible your terms, the less strain you’ll put on your cash flow. Remember, vendors are more likely to provide favorable terms if you’re in good standing with them. Having a strong business credit score can go a long way here.

One more piece of advice on this topic?

Prioritize your payments by interest rates. For example, pay off credit cards with higher interest rates before paying off a low-interest bank loan. That way, if you do fall behind on one of your payments, it won’t be the one with the highest consequences.

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5. Carefully manage your inventory

Just like exercising versus relaxing or prioritizing alone time versus spending time with friends, knowing when to buy inventory versus save money is a fine balance. While your products can help increase your cash flow through sales, they also require a sizable portion of cash.

Here’s what we mean: Too much stock and your cash won’t be converted quickly enough, which can then lead to cash flow issues. Too little stock and you could hinder your sales.

So how do you know what just the right amount is? Having a broad picture of your real-time inventory is crucial to managing your products and cash flow. One way to optimize your inventory is by using a point of sale (POS) system with inventory management capabilities. Your POS can show you day-to-day inventory changes and run reports that cover longer periods of time, empowering you to adjust your stock levels accordingly, free up cash flow and streamline your business across multiple locations.

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6. Evaluate how you’re borrowing money

In today’s high price tag world, borrowing money is often the only way to move forward. As a result, many small businesses rely on business loans, business credit cards and other forms of short-term lending to make ends meet or fund growth projects. If you’re one of them, you might want to reevaluate your borrowing strategy to maximize your cash flow.

If you’ve been paying through the teeth on sky-high interest rates because you thought you had no other choice, you may have more options than you think. To help loosen the purse strings on your cash flow, it’s worth checking with your financial advisor to see if you can refinance any high-interest debt into lower-interest loans for a cheaper cost of borrowing long term.

Another tip?

If you don’t like the rates you’re seeing, you don’t have to settle for the first lender or business credit card issuer you come across. Shop around to find the best terms for your business.

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7. Increase sales, not expenses

It’s no secret: For a healthy cash flow, you need to increase profit margins and sales while keeping your operating expenses low.

We get it. While it’s an easy recommendation to make, in reality, it’s much harder to achieve. One of the keys to increasing sales is expanding your customer base. To attract new customers, you’ll need to implement a thoughtful marketing plan that promotes your brand across multiple channels and targets new audiences.

But that’s just one side of the coin. While winning over new customers is wonderful, retaining loyal customers should be your bread and butter. After all, they’re your best resource for referrals. To keep your regulars coming back, keep delivering the excellent customer service they’ve come to expect — and do your best to retain the great employees who make the magic happen.

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8. Build up a cash reserve

The thing about emergencies? You never know when one is going to knock on your door. That’s why it’s important to plan for emergencies when the waters are smooth.

To ensure healthy cash flow during tough times, you need a business emergency fund. Whether it’s the result of a few slow months or consumers responding to a general market downturn, there might come a day when your cash outflows are outpacing your cash inflows. During times like these, a cash reserve can help you pay off capital expenditures and cover any shortfalls.

If you wait for an emergency to happen to learn this lesson, it’ll already be too late. So be sure to build a cash reserve in good market conditions when your company has positive cash flow. Depending on your business needs, target three to six months of business expenses for your cash balance.

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Ready to work with a partner who knows what it’s like to manage cash flow?

As we just saw, managing cash flow takes a lot of work. The good news? You don’t have to take it on all by yourself.

From a guided lending solution that compares the best rates on the market for you, to POS technology with powerful inventory management features, to cloud-based billing and invoicing software and so much more, Heartland’s suite of financial technology can help you free your business’ money — without the heavy lifting.

Reach out anytime to learn more about how we can help you achieve positive cash flow and unlock growth for your business.

Frequently asked questions (FAQs)

There are lots of actions you can take to manage your small business cash flow. Read back through the article for the best small business cash flow management tips — from how to increase sales to rethinking your accounts payable and receivable policies.

Small businesses often run on razor-thin margins. As a result, many small business owners fail to save any cash reserves. However, it’s a best practice for small businesses to have a cash reserve that covers three to six months of operating expenses.

Some causes of negative cash flow include low cash reserves, expensive borrowing rates, low sales or profit margins, mismanaged inventory or too many outstanding receivables.

Cash flow is the total amount of money that flows both in and out of your business. Profit is the amount of money left over after a company pays its expenses in a given period. While you might have a lot of money coming into your business, your expenses could still cause low profit margins if the cash flows right back out to pay off your costs.

Calculating cash flow via the direct method is a straightforward formula. You simply tally up all your cash inflows and subtract all your cash outflows. The difference you get is your total cash flow.

The most common source of cash flow for small businesses is the income from the sales of goods or services. While bank loans, investments and other funding can play a role in cash inflows, the most significant portion of cash inflows still comes from sales.

Disclaimer: The information provided in this document does not, and is not intended to constitute legal advice; instead, all information, content, and materials available are for general informational purposes only. Information provided may not constitute the most up-to-date legal or other information, and readers of this information should contact their attorney to obtain advice with respect to any particular legal matter, in the relevant jurisdiction. All liability with respect to actions taken or not taken based on the contents here are hereby expressly disclaimed.

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