Managing cash flow as a small business owner

Effectively managing your cash inflows and outflows is crucial for the survival and growth of your business, but even such a simple task can become complicated by the realities of running a business. Here are some of the common problems business owners face when balancing their books, and how to combat them.

Understanding cash flow

Cash flow describes the money moving into and out of your business (inflows and outflows) at a given time. It’s a continuing variable in business financial planning, and is used to calculate liquidity and ratios that measure financial health.

Cash flow vs. profit

It’s important not to confuse cash flow and profit. Cash flow refers to the amount of money flowing in and out of your business, while profit is specifically the amount of money left over after your costs and expenses are covered. Changing cash flow can affect profits, but so can variable costs, expenses, and consumer demand.

Common cash flow problems

Much like water flow, cash flow can be interrupted or diverted without proper management, leading to disruptions. Here are a few cash flow problems or disruptions that can impact your business checking account:

• Late payments: Customer revenue is a critical source of cash flow for most companies, and when customers pay late, they disrupt cash flow.
• High overhead: Cutting costs is a basic cash management technique small businesses rely on to improve liquidity—high overhead dampens those efforts.
• Insufficient cash reserves: If your business doesn’t have enough cash set aside to cover slow sales periods, things could cascade into even more cash flow problems.
• Excess inventory: Unsold or unmoving inventory can skew your cash flow forecasting and drain your overhead budget.
• Rapid growth: Increasing inventory, staff, or operational capacity too quickly without a liquidity cushion—like a term loan or line of credit—can create cash flow problems.
• Poor financial management: Inefficiencies and mistakes in manual bookkeeping and accounting can create incorrect data on cash inflows and outflows.

Other examples of cash flow problems include seasonal fluctuations in sales, overdependence on too few clients, over-investment, suppliers not allowing credit or limiting credit periods, or an owner taking too high of a salary.

Cash flow mistakes to avoid

Here are some of the most common cash flow mistakes small business owners make, their potential impact on long-term growth, and how you can avoid them to keep your cash flow on track.

Not forecasting cash flow

Your existing financial data is important, as it can help you predict your cash flow for different periods of the year or business cycle. Small business owners who rely on incomplete data—or no data at all—will inevitably be surprised by shortfalls and missed growth opportunities. They’ll be more likely to miss payments or receivables, to the detriment of their financial health.

To avoid this problem, use a banking platform that automatically tracks your spending, and analyze this data using an accounting platform that’ll forecast your cash flow. This will help you avoid overspending and adjust for seasonal fluctuations.

Not staying on top of accounts receivable

If you offer periodic or credit payments, you’re more likely to have unpaid invoices pile up, which can quickly obstruct your cash flow by blocking your funds from being used when they should be available. To avoid this problem, use an automated invoicing platform that will send invoices, reminders, and late payment alerts on your behalf. Early payment discounts and other incentives can encourage timely payments, too.

Mixing personal and business finances

Using one single bank account or credit card for both personal and business purchases can quickly become confusing, and potentially costly if you file your taxes incorrectly. Your business and personal credit scores are separate, but they each impact your ability to receive business loans, and they can each be complicated by mixing your finances.

To avoid this problem, open a separate business bank account and only make business purchases with the debit and credit cards for that account. This will also help you track expenses and simplify your taxes. If your employees need to make business purchases, use a business checking account that supplies multiple cards and virtual cards to avoid having to reimburse personal purchases.

Mismanaging inventory

Buying too much or too little inventory will constrict your cash flow by impacting the amount of inventory space you have or the number of sales you can make. To avoid this problem, implement an inventory management system and choose appropriate software to automatically track sales and optimize stock levels.

Neglecting your tax planning

Failing to set aside sufficient funds can result in a cash flow shock when your taxes are due. Unexpected bills of any kind can deplete your cash reserves, but you have fewer options for delaying or refinancing tax debt compared to other kinds. 

To avoid this problem, work with an accountant (either in-house or third-party) to estimate the taxes you’ll owe on your business finances. Reserve some of your revenue in a sub-account of your business checking account, and make quarterly estimated tax payments to avoid having too large a lump sum once per year.

Cash flow management strategies

Small business financial management typically requires a mix of cash flow and cash reserve strategies, such as the following:

1. Optimize your business banking: Finding a banking provider that offers automated accounts payable and competitive interest on your business balances.
2. Offer incentives for customers to pay sooner: Offer incentives for early payment, such as discounts or loyalty programs.
3. Ask for a deposit or milestone payment: When making large sales (such as to vendors), asking for some or all of the money up front helps your company cover manufacturing and distribution costs and—in the case of periodic payments—lowers the likelihood of delayed or missing payments down the line.
4. Request more favorable payment terms from vendors: Ordering in bulk or asking for better net payment terms can decrease cash outflows to your vendors.
5. Finance purchase orders: Manufacturers and merchandise companies sometimes offer purchase order financing, in which a financier pays the vendor directly in exchange for a share of the order amount.
6. Sell or lease idle equipment: Your unused equipment could be useful to another business—sell or lease it to increase cash flow.
7. Sell invoices: Unpaid invoices in your accounts receivable file could provide instant revenue if sold through a B2B factoring or financing program.

Cash flow tips for specific industries

None of these strategies is a one-size-fits-all solution because each industry has specific cash flow challenges. For example:

• Ecommerce and retail businesses face fluctuating demand and high shipping costs, and can optimize cash flow with the right inventory management system to help weather seasonal fluctuations, and by negotiating with suppliers.
• Construction companies tend to deal in long-term, high-cost projects. Requesting upfront and periodic payments, as well as term loans and lines of credit, can ease budgeting difficulties.
• Professional services companies can help manage cash flow by automating invoices and late payment reminders. Discounts for long-time contracts or clients can also help customer retention.
• The restaurant industry has highly variable costs, which can be eased by optimizing shift schedules, loyalty programs, and penalties for late cancellations.

Take control of your business’s cash flow

To ensure your business remains financially healthy and prepared for long-term growth, avoid the common cash flow mistakes and implement the management strategies above. Cash flow management is a continuous process that requires you to pay attention and adapt to changes in your business and the economy. By using automated business checking and accounts payable platforms, most of that work will be done for you, so you and your team can focus on strategy.