What’s more important than profits? Cash. Your profit margins can change at any time, but your cash flow determines your business’s current and future health.
Cash flow is the money that flows in and out of your business, and is a crucial indicator of its financial health. Any business may be at risk of poor cash flow, and if its major causes are overlooked, the business may become unprofitable, dwindle further, and have to shut down. Knowing what can affect your business’s cash flow and how you can limit unnecessary cash outflow will help you manage it consistently, prepare for challenges, and grow steadily!
Negative cash flow: how it can affect your business
Negative cash flow is when your business spends more than what it receives, but this need not always indicate a loss. For example, your payments may be due before you receive your income and you may spend more than what you have at that time, leading to a cash flow problem. So, while you may recover your money later, or even if you’ve already been profitable, there will be certain months where you’d be spending more than your earnings. This can prevent you from having enough cash for future investments, leading to an imbalance in your revenue along with a decrease in your liquid assets.
If you don’t manage your cash inflow well to face unexpected expenses, you may have a cash flow crunch. To tackle this problem, you have to understand what’s causing the shortfall.
Common causes for negative cash flow
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Inefficient management: Poor productivity and marketing strategies can make you spend a lot without receiving adequate returns on your investment. For instance, your staff may be focusing on tasks that could be automated, or your marketing strategy may not be effective enough for your target audience. These may lead to high operating costs, as well as poor sales and credit ratings.
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Incorrect pricing: Undercharging or overcharging is another common reason for negative cash flow. If you have low profit margins, you might want to raise your prices. However, charging excessively for something that customers can get for a lower rate (with the same quality) will only discourage them from buying from you. Similarly, not charging enough can lead to lower returns, and will not improve your position in the market.
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Late payments: The more complicated your invoicing and payment process, the later your payments are likely to be. Delayed payments can hurt your cash flow, and affect your ability to pay your own vendors, pay for overhead expenses, and much more.
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Unnecessary investments: Investing too much on products or services that aren’t critical to your business can affect your cash flow. When you do this, you’re spending on non-essential assets that won’t give you much returns, leading to your funds getting drained.
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Improper planning: Failing to set long-term goals, expanding too quickly, or not having the right employees can impact your future opportunities and your brand image, all of which will hit your revenue. Things may look up temporarily, but you may not have enough resources to give you good returns. Poor financial planning will leave you short of funds when you have unexpected expenses, and you may become too dependent on loans without having enough cash to repay them.
Managing poor cash flow is important, but so is steering your business towards consistently improving your revenue. Here’s how you can do both, in two stages.
Stage 1: Survival strategies to manage poor cash flow
Money matters
Record and review your operating expenses and financial statements on a bi-weekly or monthly basis (depending on the size of your business), so you’re always updated on where your money is going to or coming from, and you can take action accordingly. You should also run a cash flow statement because this will help you understand how well you’ve been managing your cash flow.
To prepare for the unexpected, you can keep aside a certain amount of cash every month as a cash buffer. This amount can be determined based on your general expenditure, your current and past performance, and how quickly your products get sold. If your overall performance is slow and indicates that you need more money for an emergency, you need a bigger reserve.
If you can’t do this and urgently require cash, invoice factoring (selling unpaid invoices to companies in exchange for immediate cash) may help you get cash right away. However, the factoring company will take a cut of the money you earn. Alternatively, you can opt for a business loan.
Ultimately, be mindful of the amount you spend during this period, and cut down on unnecessary expenses. If you need to pay for a business expense, prioritize the resources that will help you improve your cash flow and grow your business (whether long-term or short-term). For instance, if you had to choose between revamping your office space and purchasing new software to help your business processes, the latter would be far more beneficial.
Avoid delayed payments
Send out invoices as soon as possible and have a written record of your payment terms and conditions so your customer knows the consequences for not paying promptly. You can also incentivize them for prompt payments, or, if they opt out of cash payments, check their credit score to ensure they have a reliable record.
In case you want to make a sale to a customer who doesn’t have a promising financial history, do so at a high interest rate; they’ll buy only if they really need to and it’s more likely that you’ll get your money back. Meanwhile, ask your vendors if they can extend the payment terms, and regularly check your AR aging report. This will provide details of payments that have crossed the due date, so you can follow up with these customers and recover your receivables.
Stage 2: How to improve cash flow and grow consistently
Pay less or buy more
Having enough cash for your day-to-day operations is important for good cash flow management. When you lease a product and rent it from the supplier, you can use it without spending excessively, only paying small amounts each month. This helps cash flow, especially because these expenses can be written off on your taxes. Similarly, if you’re purchasing a product, ask if you can pay in installments.
You can also buy your supplies in bulk to get good discounts. In case you’re unable to buy in bulk as a sole entity, partner with similar companies and pool your cash together so you can get your vendors to lower their prices.
Make payments easier and incentivize customers to pay on time
While sending out invoices, attach a payment link to help your customers pay immediately with just a click. Offer electronic modes of payment; they’re easy and quick! Your accounting software can simplify the process by helping you with online payment integrations and instantly getting your invoice sent with the right payment options.
You can also ask for partial payments up-front (especially from newer customers) and encourage them to pay faster by offering discounts for early payment. Implementing reward programs and referral programs can work in your favor, as you can grow your sales and churn more revenue, while your customers also gain when they buy from you!
Make your invoice easy to read for your customer, so they’ll understand the terms and conditions. State the due date clearly, with information on accepted payment modes and late payment fees, if any. Once they’re sent, send invoice reminders a few days before the payment’s due date. You can make this work smoother if you automate your AR/AP process.
Monitor your inventory
Conduct an inventory valuation on a quarterly basis, noting the goods that aren’t moving quickly or aren’t in much demand. These goods, which become dead stock, could affect your cash flow. So, cut down on buying these in the future and liquidate what you currently have, or even sell them at a discount so they’ll move faster.
Negotiate with vendors and extend payment terms
Once you’ve established a good rapport with your vendors, you can negotiate with them to give you discounts for paying early. If you need more time to pay bills, ask for extended payment terms (you can do this especially for large purchases). If you’re a regular buyer with a history of prompt payment, your vendors will most likely agree, and this will give you more time to make your sales before your due payment to the vendor.
Be proactive with cash flow forecasting
When you prepare a cash flow forecast, you estimate your future income and operating expenses, helping you build a budget and plan better. You can do this by analyzing the previous year’s performance or by calculating your expected inflow (like customer receipts) and outflow (like vendor payments and payroll).
It’s best to forecast monthly or quarterly to keep track of your key performance indicators, helping you understand your working capital, and whether you have enough income to manage the following month’s requirements. Once you finish forecasting a period and move on to the next, return to your forecast for the previous period and check your estimation against the actual cash flow; if there’s a mismatch, you’ll know the difference and understand why your cash flow didn’t meet your expectations.
Invest well and use bank accounts safely
Make your idle cash work for you, and invest wisely. If required, you can even take short-term loans, where you get a lump sum amount that can be repaid in installments. This borrowed amount can be used to make smart business decisions that will help you in the long run, such as expansions, purchase of new inventory, and more.
You can even make payments with a cash-back business credit card (where you get a certain amount of money back after a successful payment), which will be helpful for regular monthly payments. Use a checking account (also known as a current account) to deposit a portion of your income regularly as a reserve, and to deposit the rest of your income, use a savings account that will yield high interest. To make it simpler, you can keep transferring your money from the checking account to the savings account, so if your funds go below the minimum requirement for a checking account, they’ll get transferred back automatically. This way, you can save money for an emergency.
It’s equally important to keep your bank accounts secure and decrease the chances of unauthorized use. For instance, you can minimize the number of people who can access it, so you ensure your money is in safe hands and won’t be spent without your knowledge.
Plan for a steady expansion and raise prices
If a certain product of yours is doing well in the market, bump up its price by a marginal amount. Check if your own expenses for equipment, manpower, and time have increased. If their value does not match the final sale amount, reassess the price. However, take a look at your competitors’ prices as well, and make sure that yours isn’t raised too much in comparison. If you’re raising your price, be sure to let your customers know how much they can gain by buying from you.
For example, if you’re manufacturing chocolate and adding a unique ingredient to it, highlight that. You can even provide an add-on or an extra feature to your product, making it different from the rest. Meanwhile, add new categories and products to your business, and expand slowly but steadily. Consider other customer groups you can target who could benefit from your products, and encourage them to spend more by selling in bundles. So, taking the previous example, you could expand your sweets business to include healthy sugar-free variations and, later, even target healthy beverages.
However, while expanding, it’s important to make cost-effective choices. If it gets too expensive to handle everything on your own, outsource certain functions, and regularly review your existing contracts. Streamline your business processes by investing in more efficient software and equipment. While this may initially be more expensive, it will cut a lot more costs for you in the long run.
It all boils down to how you take things forward with your money. Negative cash flow is common in growing businesses, and if you’re able to spot the issues as they occur and solve them, then you’re good to go! To improve cash flow for your business, prioritize resources that will bring you returns, plan ahead, focus on your cash flow statements, and stay on top of your forecasting. Build up from there and work on the tips mentioned above so that you can safeguard your business and keep it growing at a steady pace.
By Mercy Johny for Zoho