How Does Cash Flow Management Work in Small Businesses?

Cash flow, in simple words, is the money flowing in and out of your business. Managing a business or company’s cash flow provides owners with a bird’s eye view of their financial health. This overall view helps owners make sound decisions for their business backed by financial evidence. It also makes it possible for owners to understand their spending patterns and provides them with rich insights that will allow them to make timely expansion plans. Managing cash flow is also a means to efficiently monitor the receipt of payments and ensure that good business relationship are maintained with vendors and customers alike.

Why is cash flow management important?

Poor working knowledge of your business due to mismanagement of cash flow often leads business owners to fall into a quicksand of poor decisions. This can manifest through decisions like high spending when there is little to spend,  hiring labour and purchasing capital without a budget that would allow these purchases, hiring the wrong people and putting emotions before financial logic. All of this can be avoided by keeping track of your cash inflows and outflows.

Cash flow management is the fuel that keeps small businesses running. Putting meticulous hours into keeping track of your inflows and outflows allows you to stay on top of your transactions and helps build trusted relationships with your customers.

There are different metrics you must track to get a complete idea of how your business is doing. Before diving into how to conduct effective cash flow management, you must thoroughly understand these metrics. You must also know what these transactional terms mean so that you can monitor your business performance. These terms are cash flow, revenue, profit and loss statements, and working capital.

Transactional metrics for evaluating business performance

As mentioned already, cash flow is the amount of money moving in and out of your business during a specific period. It can be positive or negative.

When your cash flow is negative, it means that more money is going out of your business than coming in. Accordingly, when your cash flow is positive, it means that more money is coming into your business than going out. Positive cash flow allows you to have money to pay your bills and additional expenses. With a negative cash flow, you may not meet your financial obligations.

While cash flows account for both positive and negative flows of money, revenue only means the positive flow of money into your business.

Profit and loss statements are a brief picture of the amount you are left with after you have received all your earnings and paid all your bills. While this gives you direct information on how much money you are making, it is not comprehensive. On the other hand, cash flow statements comprehensively record the net flow of cash in and out of business.

Both these metrics are important indicators of the health of your business. Unfortunately, they are often pitted against each other in terms of the insights they provide. But it is a good practice to have a firm hold over these metrics for a sound knowledge of how your business is performing.

Working capital represents the assets you own that can get converted into cash to pay your financial obligations. These obligations can be purchasing inventory and paying salaries.

How can you effectively manage your cash flow?

Once you have a firm understanding of these metrics, you can delve into some handy tips on effectively managing your cash flow as a small business:

1. Identify business risks in advance

Studying your area of business, potential risks, and being prepared for significant events in your business can help you stay afloat. For example, if you do not get the orders you expected, how would you manage your inventory? If you suddenly face a spike in orders, would you have the cash to finance the purchase of urgent equipment? Finally, how would you address the situation if a client fails to pay?

These are questions that would help you plan your cash flow management. Once you have done some preliminary research in the sector in which you choose to establish your business, you will be able to jot down such questions and identify the key financial areas that require your attention.

2. Set up a separate bank account for your business

New entrants into a business often make the common mistake of mixing their business cash flows with their accounts. Therefore, it is strongly advisable to have a separate account for your business. Link it separately with different third-party payment apps that you are using. It is also a good practice to keep these third-party accounts separate from your personal payment tabs.

3. Use dedicated storage tools to ensure effective bookkeeping

While accountants manage bookkeeping in big businesses, it is not affordable for small businesses. A good alternative would be to rely on dedicated services that are available for the same purpose. OkCredit is one of these services that provide you with the necessary cash flow management tools to track your reports and account statements while keeping your data safe and secure.

4. Being professional with your customers and upfront about your payment requirement

Having a good relationship with your customers and being strict with your payments is not mutually exclusive. For example, ensuring that one of your customers makes a timely payment would mean that you do not leave another client with a delayed output due to pending bills.

5. Analyse your cash flow periodically

Depending on the scale of your business, analyse your cash flows to identify pain points. It can help cut unnecessary spending and identify sources of added cash flows. It can also give you insights into where you can increase your margins and where your expenses can get delayed.

If your business has a strong demand, raising your prices would be a good strategy. Ensuring that this increased margin does not alienate your customers is crucial to your business strategy.

Alternatively, if you cannot raise prices, find alternative ways of increasing your cash flows for your small business. Selling or leasing idle equipment can be an excellent strategy to accumulate cash during crunch times.

Too Long, Didn’t Read

Periodic analysis of comprehensive cash flows of your small business can be a gamechanger for business management.

‘Cash is King’ is a cliched yet accurate way of describing the importance of managing cash in any business. Unfortunately, 80% of businesses go belly up due to poor cash management and rarely due to the failure of the business itself. Have a firm grip over your cash flow based on thorough research of your market and clientele. This practice can help you make long-lasting, effective decisions regarding financial management. Adopting meticulous bookkeeping and analysis can save your time and decide the make or break of your business.

Download OkCredit today to start your journey of responsible bookkeeping!

FAQs

Q. What are some early signs of unhealthy cash flow?

Ans. You should be able to hear the warning bells ringing when multiple customers owe you money, despite delivering the product. Relying on payments from big customers can be risky and might delay your bills and expenses.

Accumulated short-term debts are also an indicator of an unhealthy cash flow. It calls for reducing cash outflows or finding a way for increasing cash inflows.

Q. How do I do a cash flow analysis?

Ans. You can do a cash flow analysis by completely recording each expense and earning. Maintain a physical ledger or use dedicated mobile applications to do this. You can decide your period of analysis based on the size of your business and the volume of your transactions. It can be weekly, monthly, or bi-monthly. This analysis will give you insights into your average expenditure during the period and your rough trade volume.

Q. What are some critical factors that affect your business’s cash flow?

Ans. Inventory: Having a rough idea about the optimal inventory you can afford based on your sales can help you make suitable investments.

Sales: Generating sales significantly drive more cash flow to your business. While generating sales, you also can raise your prices according to how well your product is doing in the market.

Accounts receivable: These are the payments your customers owe to you. Ensuring timely payments and asking for a deposit before the product is delivered can help you manage your business cash flow better.

Accounts payable: These are the payments that you must make to keep your business afloat. Ensuring timely payments to your vendors can mean better relationships. These can help you score discounts later.