Managing your business’s cash flow is critical to success.
Imagine your operation is a river – and the cash flow is the water. You should be building dams and maybe shifting the banks to keep that water moving when and where you need it. All businesses need to invest in income-producing assets, like accounts receivable, inventory and equipment.
Very often what you need costs more than the credit you can get from suppliers—by a lot. To stop your river from drying up, you borrow from another source, like a bank or your own capital. Bank financing can be hard to come by for a new business, which leads to a lot of pressure for an owner.
In our experience as Chartered Professional Accountants working with small businesses, we have seen most owners struggle with ‘water levels’: raising enough capital to make sure everything is financed effectively. If you don’t have enough, you’ll constantly be juggling cash flow to make sure you can pay wages and suppliers on time.
Earlier we looked at collections and cash flow management, offering tips to improve your collection cycle and help put cash in the business. Today we’ll look at ways to manage payments to improve cash flow availability.
Most small businesses choose to stretch out their payables first. This is a classic example of a works-in-the-short-term, hurts-in-the-long-term scenario. Suppliers will slow down shipment of products and services if they don’t see their money in an appropriate time frame. And that hurts your profits.
Here’s one possible solution: you can split purchasing between suppliers. It eases the pressure. But for this to work you need to have more than one appropriate supplier for your particular products.
You also need to make sure you only stock inventory that can be sold quickly. One of the biggest small business problems is having inventory sit in a warehouse for ages. It absorbs large amounts of working capital and ultimately reduces profitability—you’ll most likely have to drop the price to move the stock.
Businesses should always take advantage of payment incentives. Many suppliers offer terms such as 2% if paid in 10 days and net 30 days. If you forego the discount, you’re paying 2% interest for 20 days’ financing. That adds up to an annual interest rate higher than 37%.
We also think businesses should consider leasing equipment instead of owning it. This lets you spread out the cash flow requirements to pay for equipment over its useful life. There is often a higher interest cost involved, but it can be very advantageous in managing cash flow.
Management can also control the problem by investing time and effort into creating a cash flow forecast. As part of your business strategic plan, having this type of projection gives a solid indicator of when you’ll need cash, how much you’ll need and also when you’ll have a surplus. If you know how much money you’ll need for something, you make better decisions if you have to manage a shortfall.
For most small businesses, proper cash flow management is a critical determinant of business success. This is especially true in the early years. If you can direct your “river’s” flow, you’ll sustain a healthy business ecosystem for years to come.