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You've had your small business for a few years, and even through the pandemic, you’ve managed to stay afloat. You have products (digital or physical) on shelves, customers making purchases, and your books show profits. Even if it appears that you have a profitable business from the outside, however, one of the most critical indicators of success for small businesses is that they maintain a healthy cash flow.

So, what does your monthly cash flow look like?

Most small business owners are heavily involved in their business finances- You probably spend a decent amount of your time tending to accounts payable statements, reviewing your accounts receivable reports, and monitoring how much cash is in your bank account. These financial tasks are essential to creating a positive net income, but checking your bank account balance doesn't give you the figures you need to manage cash flow properly.

Instead, you need to be monitoring the most crucial yet most widely misunderstood component of business growth - your cash balance - cash inflows versus cash outflows.

Cash Flow For Small Business

First, let’s start with the high-level question, what is cash flow?

It’s the amount of money that moves in and out of your business. Healthy cash flow is also associated with liquidity and raising money when you need it. Therefore, your small business must have regular cash flow, not just a stacked accounts receivable report.

Positive cash flow is the lifeline of a small business. You want to have more money coming in than what it takes to pay your business expenses- taxes, employee wages, cost of goods, and utilities.

Calculating cash flow with spreadsheets is an excellent way to assess your small-business expenditures to determine your overall financial health. For example, you might be spending more money on the cost of goods than you're selling. As you monitor and calculate cash flow often, you might notice you're spending money on large orders at a better price point per item yet keeping much of that product in inventory for several months at a time.

This cash flow problem, for example, might be quickly resolved by negotiating with your current vendors or finding new vendors who offer extended payment terms and allow for smaller orders, even if the price is a little higher. This way, you can make smaller orders more often and avoid tying up your cash flow in inventory for months at a time. You may find that smaller, more frequent orders allow you to maintain more cash on hand and will enable you to address other business needs better.

Cash Flow Management

Cash flow management can be complicated, especially if you, like many small businesses, have vendors and clients that are billed monthly. For example, let’s say you purchase products from your vendor and pay that invoice in 3o days. Your customers, however, pay for their invoices in 60 days. If this is the case, you've accidentally created negative cash flow in your small business.

Your customer's extended payments are directly correlated to the cash flow problems in your small business. As you notice patterns like this in your cash flow statement, you'll feel empowered to reevaluate and renegotiate terms with your customers. Anything you can do to get cash flow in the door more often increases the amount of money moving throughout the business each month.

Balancing your accounts receivable and your accounts payable is critical. To correctly manage cash flow problems, create cash flow statements that analyze your cash position in detail. Talk to your bookkeeper about cash flow measures and enlist their help in monitoring the amount of free cash flow your business has on a weekly and monthly basis. They may have valuable suggestions and feedback in regards to your accounts payable, accounts receivable, and cash flow statements that will ultimately help you increase cash flow in your business.

If you risk losing patrons by changing payment expectations, it might be time to discuss options for extending your payment terms with your vendors. For example, matching your vendors' billing cycles with your customers' timing of paying bills can decrease a negative cash flow.

Ask your suppliers about discounts you can receive for making early payments and explore how you might set up automatic payments and accept online payments from your customers. These types of financial arrangements can help you and your customers avoid late fees and can improve cash flow and the overall financial health of your small business.

Optimize For Positive Cash Flow

As a business owner, you know that managing cash flow is an ongoing process. Observing daily operating cash flow can be an effective way to ensure that financial obligations are being met. By watching the cash flow coming in and monitoring how much money is going out, you can pinpoint cash flow problems quickly.

Financial institutions offer online banking to simplify this process by giving you instant access to transactions and your cash balance. This allows you to monitor cash flow and spot cash flow issues immediately.

Optimizing your cash management is about being financially strategic. Think of ways to improve cash flow in a variety of ways. For example, how can you offer services that will enhance positive cash flow long term?

1. Consider offering your customers a discount when they pay early. Offering an early pay discount is an excellent incentive for quicker cash inflow.
2. Send your invoices promptly—research options for a digital platform that will allow you to send your invoices instantly and effortlessly. Billing and invoicing software can reduce the time you spend sending bills and help you get paid faster. The faster your customer receives their invoice, the quicker they may pay, thus improving cash flow and reducing the time your customers sit on your accounts receivable list.
3. Accept credit cards and electronic payments. Allowing customers to pay their invoices with technology is a great way to improve your cash flow since digital payments post much faster than if you were to wait for a check to come in the mail.
4. Negotiate pricing with your suppliers. One of the best ways to control your cash outflow is by talking to your vendors. Just as you may give your customer a discount for paying early, your vendors may give you the same option.
5. As a business owner, deciding to raise your prices might be difficult, but keep in mind that many companies raise their prices annually or bi-annually. Therefore, increasing your prices keeps your business competitive and can create more cash flow and net income.

How To Do A Cash Flow Analysis

Business owners who conduct a systematic cash flow analysis have more control over their financial performance. An excellent general rule of thumb is to review your cash flow statements every four to six weeks.

Identify your income sources. Where is the money coming from within your specific timeframe?

Identify your business expenditures. How much are you spending on your business in that same timeframe?

Create a cash flow statement. You can create a cash flow statement now that you have identified your business income and expenditures. There are usually three parts to a cash flow statement- operating activities, investing activities, and financing activities.

Operating activities are reflected by the income generated minus your business expenses. So the best scenario here is to have a positive number, which indicates a positive cash flow.

Investing activities include buying or selling property, equipment, and other assets. Cash flow is affected by the purchases and payments you're obligated to make. Cash flow from investing activities can also be affected by the income of interest or profit from these investments.

Financing activities refer to loans and loan repayments. Cash flow in this category could also include buying and selling company stock.

Now that you have your cash flow statement, you need to be looking for patterns. For example, you can see whether your business is earning more cash each month than the amount paid out and what funds may be tied up in debt. Remember that profit and cash flow are not the same.

How Much Cash Flow Should Your Business Have?

Many small business owners struggle with knowing how much cash flow is sufficient to maintain operations. This can be particularly difficult as a brand new company. However, creating cash flow projections can help give insight into the overall operating costs and minimum required cash flow needed to cover basic business operations.

The general rule is to have enough money so that you can sustain three to six months' worth of operating expenses set aside. The best way to do this is to slowly build up a cash reserve in a separate business savings account that could cover wages, the cost of goods, utilities, and all other expenditures in an emergency.

This cash flow rule of thumb has never been so important as in recent years, with the pandemic hitting small businesses so hard. Even with cash flow reserves, many small businesses didn't have enough cash to survive through the economic downturn.

It's wise to manage cash flow in your small business so that you can set aside even more cash than a 6-month reserve. Look around at some other small businesses that have failed in your local area - if they'd had more than six months of cash flow covered, would they have survived?

If nothing else, this proves how crucial managing cash flow is for small businesses and especially as they face unpredictable market and economic cycles. In this way, the recent pandemic has changed how lenders, investors, and small businesses look at cash flow management.

Why Your Cash Flow Statement Is Important For A Small Business Loan

There may come a time when you just don't have enough cash on hand to make the big moves needed to grow your business and reach the next level. For example, maybe your business needs to expand, relocate, or remodel. As a result, it might be time to borrow money. Many small business owners rely on business loans to give them enough operating cash to help their long-term financial success.

Lenders consider many factors when determining whether a business qualifies for a business loan. One of the most significant factors they consider is the business's cash flow.

Yes, your lender will look at the business expenses, but they will also look at your taxes. Tax records show the lender what is going on in the background.

How many tax deductions did you have? What type of tax deductions did you take? Were those tax deductions legitimate to your business? Was that vehicle deducted really for the exclusive use of the company?

Your prospective lender is looking for your actual income, not the write-offs you've reported on your tax return. If there are a lot of unnecessary expenses, that could indicate a cash flow problem, and that can hurt your chances of getting a loan. Lawfully, tax deductions were designed so business owners could write off actual business expenses.

Lenders want to make sure that you have enough cash flow to repay the loan and not just rely on those tax deductions to get by.

The Bottom Line: The Rules For Cash Flow

Profits and cash are not the same.

High inventory means less cash on hand.

Incorporate cash flow projections into your business plan.

Utilize cash flow analysis - comprehensively and consistently - to keep tabs on what is happening in your business.

Invoice quickly and conveniently with your customers' payment terms no longer than 30 days

Always know your cash balance.

Cash flow management is critical for small businesses. Utilizing these rules can improve your business. If you're already using these tools, you're on the right track! If you aren't yet, make a plan to implement these to keep money moving through your business.

This way, you'll implement positive practices toward properly managing cash flow. Plus, if and when you need financing, you'll be ahead of the game!