Best Practices for Avoiding Cash Flow Problems With Your Business: A Guide

If you had to make a list of some of the most significant issues plaguing small business owners regularly, cashflow problems would undoubtedly be right at the top.

Cash flow is more than just the money coming into and out of your business. It represents your ability to capitalize on opportunities as an entrepreneur as opposed to watching them pass you by because you need more cash on hand. It's about ensuring you have the cash inflow to pay your employees on time. It's about understanding how you will pay vendors and other suppliers to get your products and services into the hands of the people who need them on time. The list goes on and on.

Based on this, it should not be surprising that an estimated 82% of all small businesses close do so because of a significant cash flow problem. When you also consider that the number of small businesses that fail to make it beyond their fifth anniversary is estimated to be 48%, it's easy to see why this is one critical aspect of being an entrepreneur that you want to look into.

To be clear, none of this is to say that if you manage to avoid significant cash flow problems, you're guaranteed to run a successful business for years to come. Unfortunately, the situation is a lot more malleable than that - there are still a lot of other variables that need to be accounted for. Proper cash flow forecasting is imperative to avoid many major mistakes new entrepreneurs commonly make. It will also help prevent disruption and can contribute to your business's ability to scale and grow larger over time.

Thankfully, getting a handle on cash flow problems as a small business owner is more accessible than one might assume. However, it would help if you kept several crucial things in mind along the way.

The Ins and Outs of Cash Flow: Breaking Things Down

First, it's essential to get a handle on just what is meant by the term cash flow in the first place. Generally, it can be separated into two categories: cash inflow and cash outflow.

Cash inflow refers to the amount of money coming into your business at any time. This is typically represented by the cash generated when you sell your products or services. Note that only some dollars that come into the organization are revenue. Mind you - you still have expenses and things of that nature to account for.

As the name suggests, cash outflow is the money going out of your business. This includes not just payments to people like your employees but also payments to vendors and other suppliers. Regular expenses and debt payments would also fall under the cash outflow umbrella.

These two concepts are closely related, and a cash flow problem in one area will immediately impact the other. If you start making late payments after payment to your suppliers, your relationship can be damaged, and you may find it challenging to find people to work with in the future. Making a late credit card or other debt payment could hurt your ability to borrow (and negatively impact your credit rating). It can even harm your reputation not just with your customers but with your employees as well.

This is why there are no such things as "small" cash flow problems." What seems like a minor issue will soon snowball into something far bigger if left unchecked, which is why you need a stable foundation to avoid these types of situations altogether.

Pay Attention to How (and Why) You're Borrowing

One of the most important ways to ensure you have a handle on your cash flow situation is to gain as much insight as possible into the money you're borrowing - and why.

An entrepreneur rarely has the money to build an entire enterprise on their own without taking out additional debt like small business loans. Many even use business credit cards and similar borrowing techniques to get up and running and ensure that things are running as efficiently as possible.

You need to pay careful attention to borrowing too much or borrowing from sources that are too expensive. If you have too many loans with a high-interest rate, you may be paying more each month than that money is bringing into your business. If you miss a payment or two, those interest rates could increase even further - causing you to take on additional debt to stay afloat.

Refinance any high-interest-rate credit cards and similar loans to take advantage of more favorable terms and conditions. Likewise, only borrow additional money if you're already strapped, or it just doesn't make long-term financial sense.

Maintain Those Cash Reserves

One of the biggest lessons many small business owners learned, given everything going on in the world over the last few years, is the importance of cash reserves.

One day, everything was going smoothly and precisely as expected. The next day, something unprecedented happens - a sudden global pandemic begins, forcing most businesses to indefinitely close their doors without any indication of when or even how they'd re-open again.

According to one recent study, 17% of small business owners said that they'd have to shut down permanently if they were faced with just a two-month-long revenue loss. This is why cash reserves are critical - they help you prepare for whatever life throws you, regardless of how unexpected it may be.

In other words, wait to spend every extra dollar coming into your business after expenses, and other payments are accounted for. Try to build up as large of a reserve as possible so that if something does happen, you'll at least be able to weather the storm for a while until you come up with a more permanent solution or until conditions return to normal.

Monitor Your Receivables

To reevaluate how devastating a late payment can be, another one of the most significant sources of cash flow problems touches on the same idea, albeit from a different perspective: your accounts receivable status.

Simply put, accounts receivable refers to the money you are being paid by your customers (either standard consumers who purchase a product or service or other businesses) in exchange for something of value. For example, if you're a B2B organization that sells a product to other companies, you likely send out invoices regularly to those customers. That represents money you are owed, but the longer those invoices go unpaid, the more likely you are to wind up in a decidedly negative cash flow position.

Not only is this a common problem that many businesses face, but it's also one that is, unfortunately, getting worse. One survey conducted in 2020 showed that for the previous two years, small business owners reported that their rate of outstanding receivables increased a massive 81%. Keep in mind that this survey was also taken before the onset of the pandemic, meaning that this number probably only increased over the following two years.

You can take a few essential steps to help prevent this from becoming a significant cash flow issue for your small business. First, make sure that you're closely following all outstanding invoices in the first place. You can only collect on invoices you know were sent in the first place. You need a system that clearly outlines who owes what amount of money, when those invoices are due, and who has paid and hasn't.

Likewise, you could offer some pricing discounts or other incentives to entice certain people who may make regular late payments. For example, if the invoice is paid immediately, you could provide a deal for a certain percentage. Or a similar reduction in prices if the invoice is paid in cash. Yes, you'll lose a bit of money from offering a discount, but you'll avoid having to wait for indefinite amounts of time to gain access to the money you are owed. Pay attention to payment terms like this as far as cash flow is concerned.

Work With a Financial Professional

Another common cash flow problem that new entrepreneurs deal with, in particular, involves attempting to handle all aspects of this part of their business independently.

By now, you're an expert in running your business - that doesn't make you an expert on the financial side of the equation. Simply keeping up with something like accounts receivable information or expenses can quickly become a full-time job, which is a problem since you already have one of those you're devoting most of your attention to.

Thankfully, the solution is clear: find a financial professional that you trust who has experience in the specific industry that you're operating. Not only will they be able to help you develop an adequate cash flow management strategy, but they can also put together essential documents like a cash flow statement and cash flow forecast data. The former paints a vivid picture of where you stand today, while the latter helps you see what you will achieve if you stay on the current trajectory.

A cash flow forecast is fundamental, and if you're on a trajectory for poor cash flow or even negative cash flow, you'll know about it as soon as possible so that you can do something about it. Even if everything goes smoothly, they'll ensure you have the most accurate and actionable information to make the best decisions for your business.

Keep Control Over Your Expenses

Finally, one of the most common cash flow problems that a lot of businesses face has to do with ballooning expenses. Yes, certain things beyond your control are "costs of doing business" - like the amount you're paying for utilities to run a physical location, for example.

But especially if you're experiencing dwindling cash flow, there are several steps you should take immediately. Take a look at all the business services you're paying for and stop the ones that aren't necessary, at least temporarily. If the issue is that your suppliers are increasing their prices, try to find ones that offer similar items at lower costs without compromising quality.

Look for opportunities to reduce your operating costs as much as possible, at least for a while. It can help ward off any impending disaster and allow you to get back on your feet through a series of strategic financial moves in the days and weeks to come.

In the end, especially in the early days of any small business, you need to come to terms with the fact that cash flow will matter more than profit. You'll break even over time, but negative cash flow and related issues could bring your organization to its proverbial knees before you know it.

Not only does something like a cash flow forecast help give you advanced notice of any problems you may encounter in the future, but it also ensures that you have the cash on-hand needed to fend off unexpected situations. It puts you in a better position to capitalize on opportunities and helps your business continue to scale and evolve. When you consider that it will also help lower your stress levels as an entrepreneur because you can spend less time worrying about money and more time putting it to good use, you're looking at a perfect storm in the best possible way.

If your business is experiencing cash flow problems or you'd like to discuss budgeting or other cash flow tips, contact our office for a consultation. We are here to help.