Cash flow is the lifeblood of any business. But keeping a pulse on your cash balance is particularly important for smaller entities where financial buffers are razor thin compared to the big dogs.
Mismanagement of this critical financial component can lead to various financial difficulties—or worse, business failure. According to a US Bank study, 82% of small businesses fail due to poor cash flow management.
If that statistic sends a chill down your spine, don’t worry. In this guide, we’ll break down the basics of cash flow management, offer hands-on tips and tricks, and illuminate the warning signs to help keep you from going “into the red.”
This is your go-to guide for cash flow management in small businesses. Let’s dive in.
What Is Cash Flow Management?
Cash is king. You use it to pay your employees. Keep your lights on. Purchase inventory. And fund business growth.
While cash flow management sounds like a technical term reserved only for controllers or accounting experts, it’s one of the most critical aspects of running a successful small business. And as a business owner, it’s a concept worth knowing (like the back of your hand.) So let’s break it down into simple, digestible tidbits.
Think of it this way: Keeping tabs on your business’s inflow and outflow of money is the key to successful cash flow management. The goal is to understand your total income and expenses and ensure that the former always covers the latter.
- Positive cash flow = Incoming cash > outgoing cash
- Negative cash flow = Incoming cash < outgoing cash
Incoming cash stems from sales and accounts receivables, while outgoing cash refers to expenses, taxes, and other payments.
In a more technical sense, cash flow management involves monitoring, analyzing, and optimizing your company’s liquidity (the funds available for immediate use.) That way, you can:
- Pool cash for emergencies and opportunities alike
- Forecast future cash requirements
- Manage receivables and payables
It’s important to note that revenue isn’t the same as cash. For instance, you may have signed your first client to your marketing agency. But it doesn’t improve your cash position until you’ve got that payment in hand.
So, if you want to secure your small business’s long-term success, prioritize cash flow management. In the following sections, we’ll explore practical tips and techniques for mastering it.
Cash keeps your business afloat and provides you with the financial stability you need to turn your business vision into reality. Plus, you’ll sleep better at night knowing you can pay your bills in the morning.
How Much Cash Should You Have on Hand?
As we’ve mentioned, cash flow is critical to any business. But it can vary significantly depending on your business’s nature and industry. Understanding how cash flow looks for different small businesses can be instrumental in helping you decide which small business idea to pursue when starting a new venture.
Some businesses, such as retail stores or restaurants, typically experience daily or weekly cash flow cycles. They generate revenue through regular customer transactions, making cash flow more immediate and predictable. These businesses often need to manage expenses, such as inventory, wages, and rent, to ensure sufficient cash to meet their daily operational needs.
On the other hand, service-based businesses, like consulting or freelancing, may have longer cash flow cycles. They might work on projects or provide services over an extended period before receiving payment. Managing cash flow in such cases requires careful planning and consideration of the timing of income and expenses.
For instance, the co-founder and CEO of uSERP, Jeremy Moser, suggests that agencies keep at least two months of cash in the bank to cover necessary payroll and operational expenses. Of course, that’s not a hard and fast rule. But it’s what worked to grow his marketing agency 7x in three years.
Keep in mind this is an agency that generates monthly recurring revenue (MRR). This business model makes cash flow much more predictable than retail or e-commerce.
On the flip side, businesses with high upfront costs or those operating in seasonal industries may experience fluctuations in cash flow. For example, a landscaping business may experience higher cash flow during the spring and summer months but face leaner periods during the winter.
Factoring in the seasonal nature of your cash flow can help you anticipate and prepare for periods of reduced income. To play it safe, you’ll want to stash away enough cash to cover at least three to six months of operating expenses.
Key Metrics for Tracking Your Business Cash Flow
Bare with us as we quickly cover the most important metrics for tracking cash flows within your business. We’ll keep it short and sweet.
Even if these topics are too complex right now, digest what you can. Then bookmark this guide, and come back to it in a few months if you need a refresher.
Net change in cash: the difference between your business’s total cash inflows and outflows during a specific period. This metric is an excellent snapshot of your business’s cash flow health.
Operating cash flow (OCF): how much cash your business generates from its core operations. It’s a helpful benchmark to determine the financial success of your core business activities.
Free cash flow (FCF): the amount of cash left over after accounting for capital expenditures, such as buying equipment or investing in other ways to grow your business. It’s a great indicator of financial flexibility and the ability to generate shareholder value.
Cash conversion cycle (CCC): how long it takes for your business to convert inventory and other resources into cash flows from sales. The shorter the cycle, the more efficient your business is at managing cash flow.
Working capital ratio: your business’s ability to meet short-term obligations. To calculate, divide current assets by current liabilities. A ratio of less than one indicates potential cash flow problems. A ratio above two might indicate inefficient use of assets.
Debt service coverage ratio (DSCR): the ratio of cash flow relative to debt repayment (including both principal and interest.) A higher DSCR suggests you’re more capable of covering debt obligations, a positive sign of cash flow health.
Understand the Warning Signs of Low Cash Balances
Running low on cash can threaten your operations, reputation, and entire business. The first step in preventing this dreaded fate is to keep a close eye on the potential warning signs of dwindling cash reserves.
Here are some of the most common indicators:
- Deteriorating cash flow metrics. Metrics like your net change in cash, operating cash flow, and free cash flow can provide early warning signs of cash flow issues. Regularly check these metrics for negative trends.
- Frequent overdrafts. If you find yourself digging into your bank account faster than cash comes in, or if you’re relying on lines of credit more than in the past, these could be clear signs that your cash reserves are dwindling.
- Struggling to pay bills. If you’re stressing about paying suppliers on time or need to negotiate extended payment terms, it’s a red flag for cash flow problems.
- Increase in debtor days. If customers take longer to pay their invoices, it can tie up your cash in accounts receivable and strain your cash flow.
- Reduction in working capital ratio: A significant decrease in your WCR can signal a decrease in the amount of money you have to cover short-term obligations, indicating a potential cash problem.
- Increase in Debt Service Coverage Ratio: A rising DSCR can mean your debt is eating up a larger part of your cash outflows, leaving less available cash for other business needs.
The earlier you spot these warning signs, the more time you’ll have to address the issue. And the more likely your business can avoid a serious cash crisis.
Stay proactive. Take these warning signs seriously and do your best to nip the problem in the bud before it spirals out of control.
Forecast Your Future Cash Flows
Keeping a close eye on your cash flow is essential for the survival and growth of your small business. Understanding when, where, and how your cash needs will occur is key to making informed business decisions. In other words, cash flow projections hold all the answers to your future business plans.
Here’s where tools like SoftLedger can make a difference. This software lets you view your cash flow status at a glance, anytime, anywhere. With this technology, there’s no need to wait for end-of-month reports. You can track incoming and outgoing funds, understand your financial position, and forecast future cash flows immediately with real-time data.
For example, you might notice consistently low cash flow in certain months. With real-time data, you can take steps to secure additional financing or adjust your business operations before you hit a rough patch. It’s like having a financial crystal ball in your hand.
Why work harder when you can work smarter and let the software spit out your cash flow statements by linking your existing tech stack and credit cards? It’s a no-brainer.
Further Reading: Learn more about unlocking growth potential using cash flow.
Create a Single Source of Truth
One of the major challenges that most small businesses face during the cash flow management process is keeping track of financial data across different sources, such as:
- Tax documents
- Bank accounts
- Cash receipts
- Credit cards
- Invoices
- Checks
Not to mention that this reconciliation is time-consuming and error-prone, especially if you store the data in different formats and locations. To overcome this challenge, invest in cloud business intelligence tools that integrate and analyze data from various sources in a single platform.
That way, you can get a comprehensive and accurate view of your entire cash flow situation. And you’re not second-guessing yourself at two o’clock in the morning if you are missing any accounts payable or cash receipts. When managing your finances, the less stress, the better.
It’s also a seamless way to keep track of those pesky outstanding payments. According to Intuit, small businesses dedicate about 10% of each workday to chasing late payments.
This figure amounts to over $8 million lost in the small business economy, which could otherwise have been invested in revenue generation, employee support, or business growth initiatives. So, save yourself lost time (and potential revenue) by keeping a bird’s-eye view of your financial statements.
Of course, if you have one single source of truth for all your sensitive financial data, you’ll need to bolster your security around this information to protect it from bad actors. And trust us—they’ll do anything to get their hands on this data.
As cyber crimes and theft of sensitive corporate data have increased (according to the FBI), it’s time to button down the hatches. How? At the very least, you should automate routine backups to keep your financial data saved in the cloud safe.
Here are a few other simple tips to help protect your financial information:
- Use encryption for financial transactions and stored data
- Employ firewalls and use VPNs for remote access
- Enable two-factor authentication (2FA)
- Train employees on data security
- Install trusted anti-virus software
- Restrict access to financial data
- Implement strong passwords
Invest in HR Tech to Reduce Errors and Streamline Operations
Payroll is not the most glamorous part of running a small business, but it’s one of the most important—and expensive. Any errors or inefficiencies in this workflow can quickly drain your excess cash, like melting ice cream on a hot summer day.
Oh, and let’s not forget unhappy employees and even some regulatory headaches. So what’s the solution?
Step one: get a grip on your payroll with good payroll software. It automates the nitty-gritty details, reduces the chances of errors, and saves you time and money. Less time spent on payroll equals more time (and cash) to put into growing your business.
An employee hours tracker such as Connecteam or Toggl can be a lifesaver for your small business. Tracked work hours are automatically organized on digital timesheets, where you can review the number of hours worked during a payroll period to avoid costly mistakes. The best part is that you can then easily export all timesheets to your own payroll system or use the software’s payroll integrations.
If you need a more robust system, try a full-blown Human Resource Information System (HRIS). HRIS software handles everything from hiring and onboarding to performance tracking. By integrating everything into one system, you’re streamlining your most expensive workflow.
For instance, quicker, smoother onboarding. That’s less time paying a new hire to learn the ropes and more time with them contributing to your bottom line.
With the right HR tech, you can turn your biggest expense into your biggest asset, keeping your cash flow healthy and your business running like a well-oiled machine.
Lean Into Ways to Accelerate Cash Inflows
Ok, let’s switch gears to cash inflows. Thankfully, the concept is pretty straightforward. The faster money comes in the door, the better your cash flow. But how can you give your cash inflows that extra boost? Here are a few savvy tricks of the trade.
First, speed up your invoicing. Don’t wait until the end of the month. Invoice as soon as you finish the work. Better yet, get customers to pay upfront. And make it super easy for your customers to pay you. Offer multiple payment options to help speed things up and reduce friction. Think credit cards, PayPal, or ACH transfers.
Next, consider offering incentives for early payment. A small discount can work wonders in encouraging customers to pay their invoices sooner. And while you’re at it, tighten up your credit terms. If you’re offering 60-day terms, why not reduce it to 30 days?
Having a clear and well-structured contract with your clients and suppliers can help you maintain positive cash flow by setting expectations for payment schedules and terms.
Lastly, don’t underestimate the power of a friendly reminder. Automated follow-ups on unpaid invoices can gently nudge those forgetful customers. And if all else fails, don’t be afraid to chat with your clients about their delayed payments. Remember to keep it polite and professional.
Cash Flow Management Is the Key to Small Business Success
And there you have it. The nitty-gritty of cash flow management.
If there’s one thing we hope you take away, it’s this: cash flow management isn’t reserved for large financial institutions — it’s the secret weapon to your small business’s success.
Think about it. With a well-managed cash flow, you’ve got the funds to invest, grow, and seize opportunities as they come your way. And most importantly, you’re not worrying about paying the bills. Say hello to peace of mind.
Here’s to your success!
Reid Burns has his roots in the supply chain, handling global teams for private label companies. He has since transitioned to freelance work, providing thought leadership in the e-Commerce domain.