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Cash Flow Management for Small Business Owners.

Cash Flow Management for Small Business Owners. How to manage and forecast your small business cash flow with Henry Lopez, host of The How of Business podcast. How do you calculate how much cash you will have and need at a future point in time, and why is this important to help you operate a profitable small business.

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Cash Flow Management for Small Business Owners:

  • What is Cash Flow?
    • The business accounting term Cash Flow refers to the net amount of cash and cash equivalents being transferred in and out of a small business. Actual Cash received (Cash In) represents inflows of money into your bank accounts, while actual money spent (Cash Out) represents outflows – the money coming out of your bank accounts.
    • A company’s ability to create value and sustain profitability is fundamentally determined by its ability to generate positive cash flows. The goal of business is to maximize long-term free cash flow. It’s what results in a successful and profitable small business.
    • How do you determine cashflow? Your Cash Statement is a financial statement that reports on your business sources and usage of cash over some period of time.
    • Income/Sales/Revenues – these are not the same thing as CASH. Income is an accounting term that includes money received from the sale of your products or services – but it does not necessarily correspond with how much money you have in your business bank accounts.
    • Your P&L does not reflect how much cash you actually have in the bank either. Why is this?
      • Depending on your accounting method, Cash or Accrual, you may be impacting your actual bank cash balance and that’s not reflected on you P&L.
      • Inventory Purchases may not be entirely reflected on P&L until used (COGS).
      • Accounts Receivable balances.
      • The P&L does not capture principal payments on any loans.
    • Why does it matter?
      • The longer your cash flow cycle – how long it takes your business to collect payment for the goods and services you sell – or the faster your business growth rate, the more critical it is for you to monitor and plan your cash flow.
      • The number one business killer is running out of cash!
      • You must be able to anticipate and plan for the cash needs of the business, and not get caught without enough cash to cover your expenses.
      • And if you will not have enough cash, let’s say three months from now when you are making a large inventory purchase for the season, forecasting the cash flow requirement allows you the time to plan for alternative sources of cash (perhaps a credit line, credit cards, or renegotiating terms with the vendor).
      • This planning is also critical to helping you determine the impact of an investment in equipment or additional staffing, for example.
    • Who needs to worry about Cash Flow?
      • If you have Receivables. If all or some of your income is not paid up-front or at the time of delivery, then you will certainly need to carefully manage collections and cash flow.
      • If you make large periodic inventory purchases.
      • If your small business is seasonal, and perhaps you generate most of your revenues in specific months of the year.
      • You are planning for a significant investment – in equipment, building or other investments for which you are planning to pay for with the cash in the business.
      • You are experiencing an unexpected downturn in your business. And since this can apply to all of us, it’s a critical business financial skill to learn how to calculate and forecast your cash flow.
    • The Cash Flow Formula: Starting Cash Balance + Cash In – Cash Out = Remaining Cash Balance
      • Starting Cash Balance – needs to be calculated. You can’t just take your current bank balance, or the net income from your P&L, since that money may already be committed to paying certain expenses.
      • Cash In:
        • Cash In includes all cash deposits or credits to your bank accounts. This may include payments from customers/client/patients, new capital from you as the owner and other partners or investors, and loan proceeds.
        • Not all of your “Cash In” will show up on your P&L – as with these items. The Net Income on your P&L statement is NOT what is in your bank account.
      • Cash Out:
        • “Expense” is another accounting term, and may not necessarily mean what you might expect. Not all “cash out” items are actually an “expense” in the accounting sense of the term – in other words not all cash out items will appear on the P&L and some expenses, like depreciation, don’t actually impact your cash balance.
        • But as it relates to the P&L there are a number of “cash out” items that will deduct cash you’re your bank account that will not show up on your P&L, like for example the principal portion of a loan payment or inventory purchases.
        • Cash Out can include: money paid to buy raw materials or inventory, principle payments on loans, and asset purchases.
      • Use your Cash Flow Statement tool in your current financial system or download my Cash Flow Worksheet. You should also consult with your accountant to get more guidance and assistance with projecting cash flow, particularly if you are experiencing consistent issues with cash flow.

Top 10 Cash Flow Tips:

  • (1) Payment Terms
    • Communicate them clearly during the sales process.
    • Compensate your sales team based on actual collections.
    • Explain terms and early payment discount (conder offering if you don’t already).
    • Offer a prepayment discount.
    • Collect a deposit, retainer, or partial payment up-front.
    • Apply Credit Holds when necessary.
    • Improve and expedite your internal Sales to Billing process and handoff.
    • Apply technology to improve and speed up the process.
  • (2) Improve Production Efficiencies
    • Look for ways to improve the speed of manufacturing and/or delivery of your product or service.
  • (3) Improve Invoicing Process
    • Improve the accuracy and completeness of your invoices.
    • Send invoices sooner.
    • Invoice more frequently as job progresses.
    • Offer an early payment discount.
    • Communicate terms clearly, including on your invoice.
    • Apply technology to improve and expedite the process.
  • (4) Improve Your Collections
    • Actively and regularly manage your receivables. Your Days Sales Outstanding, and any collections past 60 days should be something you have visibility and are on top of if you have receivable.
    • What are your average collection days? Used your Accounts Receivable reporting to help you determine and monitor your days outstanding.
    • Insist on timely and complete payments.
    • Charge late fees.
    • Consider Credit Holds for problem clients.
    • Develop an internal collection process.
    • Use a third-party collection agency.
  • (5) Manage Your Fixed Expenses
    • Carefully manage your fixed expenses through budgeting & monitoring.
    • Avoid long-term contracts or other expense commitments that can minimize your flexibility during lean times.
    • Manage debt.
    • Avoid over investing in Capital Assets.
  • (6) Understand Your Variable Expenses or COGS
    • Do you know what your Gross Margin is? How does it compare to others in your industry?
    • Negotiate more favorable terms with your vendors.
  • (7) Plan Your Larger Capital or Inventory Spend
    • Maintain minimal inventory if possible.
    • Plan for the impact on your cash, by calculating your Cash Flow requirements, well of ahead of large expenses or investments.
  • (8) Maintain Your Working Capital
    • Maintain enough working capital. Do you know how much you need? One to two months of your fixed expenses is a good starting poi
    • Plan for seasonality or other cycles in your business.
  • (9) Establish a Line of Credit
    • Establish a traditional bank Line of Credit or other options (low-interest credit card).
  • (10) Get Help
    • From your Accountant or CPA.
  • Key Takeaways from this episode of The How of Business:
    • “Income” is not the same thing as “cash” and your P&L does not provide a complete picture of your cash position.
    • You can’t use your P&L to determine your cash position or to plan for your cash flow needs. You can only do this with a Cash Flow Projections – download my free Cash Flow Projections worksheet.
    • Running out of cash is the reason most businesses fail!
    • Use Cash Flow planning and forecasting to anticipate and plan for large expenses or investments.


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Related Podcast Episodes:

Episode 506: Budgeting Fundamentals for Small Business

Episode 406: Profit & Loss and Cash

Episode 395: Financial Projections for Business Startup

You can find other episodes of The How of Business podcast, the best small business podcast, on our Archives page.

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