When it comes to gauging the health of your small business, profitability alone doesn’t paint a complete picture. While the numbers may look good on paper, they mean nothing without a positive cash flow to back them up.
Effective cash flow management begins with identifying potential pitfalls that keep your small business from thriving. Continue reading to learn which cash flow missteps can be the most damaging, and how to keep them from wrecking your bottom line.
1. Letting Unpaid Invoices Linger
One of the easiest ways to sabotage your business’s cash flow is not taking charge of your accounts receivable. Until an invoice is paid, that’s money that your business doesn’t have available to purchase inventory, cover payroll, or fund the next stage of growth.
A relatively straightforward solution is to establish clear invoicing and payment terms so your clients aren’t in any doubt about when payment is due. Enforcing late payment penalties or suspending services until payment is made on past due accounts can motivate clients to be more timely, bolstering your cash flow in the process.
2. Being Too Lenient with Credit
Another mistake that can sideline your cash flow is extending credit to customers who haven’t proven themselves creditworthy. When you give someone the option to pay at a later date, you have to be reasonably sure that they’re likely to do so.
Ask customers to agree to a check of their personal and business credit reports and provide credit references before offering them credit terms. Look for any red flags, such as large outstanding balances or a history of late payments, which could signal that they may not be the best candidate for a line of credit with your business.
3. Overestimating Sales Forecasts
Optimism is a characteristic that small business owners should possess, but it’s important to keep that optimism in check where your sales forecast is concerned. Assuming that your future sales will reach a certain level may tempt you to overspend. That could lead to a cash shortfall if your sales projections are too far off the mark.
This is where financial statements such as your income statement, cash flow statement, and balance sheet can prove useful. Maintaining these kinds of records from year-to-year makes it easier to spot the ebbs and flows in your sales cycle so you can make more precise estimations.
4. Operating Without a Budget
A budget is one of the most essential resources in your small business owner’s toolbox. Without it, you may be clueless as to how much money the business is bringing in, how much of it is flowing back out, and where exactly it’s going.
Creating a workable budget is simply a matter of understanding how much net profit remains after subtracting your total expenses from your gross revenue. Break down your expenses and examine them carefully to see what’s eating up the bulk of your cash. From there, you can begin trimming away those expenses that aren’t imperative to business operations.
5. Not Having Sufficient Cash Reserves
No matter how finely-tuned your budget is, there’s no way to plan for the inevitable blips that will pop up from time to time. Having a financial cushion set aside for these kinds of hiccups allows you to avoid putting a strain on your cash flow.
As a general rule of thumb, it’s wise to have two to three months of operating expenses in a dedicated savings account. If you have nothing in reserves to start, create a line-item in your budget for saving and commit to setting aside a specific amount on a regular basis until you reach your goal.
6. Chasing Deals
If you run a business that relies on inventory, keeping those costs as low as possible is important for preserving your profit margin. Purchasing items on sale when an opportunity arises may seem like a win if you’re saving money, but your cash flow may pay the price.
Tying money up in inventory without having an idea of how quickly you’ll be able to sell it, and recover that cash, could leave you in a pinch. In that scenario, the better option may be using a term loan to purchase inventory — this will hedge against any major disruptions to your cash flow. Just remember that you’d need to have a firm idea of how much profit would flow from the sale of the inventory — this will determine if the cost of borrowing is worthwhile.
7. Trying to Grow Too Quickly
Growth is a good thing if it allows your small business to reach a wider audience and increase revenue, but it’s important to pay attention to the timing. If you’re pouring all of your cash into opening a new location, for example, but it’s going to be several months before it’ll be up and running, you may be inadvertently weakening your business in the short-term. Financing your business can be a solution when growth is on the agenda but you don’t want to compromise cash flow.
Take Action Now to Avoid a Crisis of Cash Flow
If you’ve made any of these cash flow mistakes in the past, the beginning of a new year is the perfect time to make a fresh start. Drafting a small business budget, revamping your credit and invoicing terms, building up some cash savings, and taking a strategic approach to long-term growth can help you keep your cash flow (and the overall health of your small business) on the right track.
