What is the top downfall of small businesses? It’s not robots taking over jobs or selling an outdated products. Most small businesses fail due to poor cash flow, with 8 in 10 businesses shutting their doors due to this exact reason.
Effectively managing cash flow can take your business from surviving to thriving, allowing you to build a generational business and enjoy some extra money in your pocket. Here are the five golden rules of managing your small business cash flow.
#1: Keep Clean Records
Keeping clean records can help you with more than just maintaining strong cash flow. In fact, timely account reconciliations and transparency into transactions can detect and prevent internal control weaknesses and the risk of fraud. All businesses are at risk for asset misappropriation and fraud, regardless of size, making it important to safeguard your business with regular oversight and clean records.
Nevertheless, clean records can help you understand your inflows and outflows. For example, if you wait six months to enter transactions, how will you track the amounts customers owe you? This can lead to a poor working relationship with your customers and increase your risk of bad debt write-offs.
Keeping clean records can also help your tax plan by projecting your expected taxable income, which allows you to uncover strategies to lower your bill. The last thing you want is to have your checking account take a big hit from an unexpected tax bill.
#2: Follow Collection Procedures
Many small business owners outline their expected payment times but fall short when it comes to implementing penalties and interest. Your invoice should clearly state your payment terms. If your customers default on their payments, don’t be afraid to charge them a small late payment fee. After all, they are placing a strain on your business by not remitting the amounts due.
If you are struggling to collect money from customers, consider implementing early payment discounts. This gives your customers an incentive to pay early and can help you improve your cash inflows. The small discount is almost always worth it when you have access to cash sooner.
Remember that you might need to make exceptions for certain customers, especially with the recent economic uncertainty. Would a payment plan help the customer remit the amount due? It’s better to receive smaller payments over time rather than no payment at all. This can save you money on legal fees and help you see some cash inflow.
#3: Leverage Debt
Countless business owners have the misconception that all debt is bad. This mindset can contribute to cash flow issues and cause you to bounce payments, leaving a lasting impact on your business. Successful business owners understand how to leverage debt and work borrowings into their cash flow strategy.
If you have a bill due that you can’t pay, do you pay the vendor late? This can result in a poor working relationship. Another option instead of letting payments become overdue is to utilize debt. Debt can take on many different forms, such as a business credit card, a line of credit, an installment loan, or a loan from a shareholder or outside investor.
Using these methods ensures your bills are paid on time and reduces stress surrounding customer payments. You no longer have to refresh your bank feed every ten minutes to see if your customer paid you. Furthermore, the interest paid on borrowing is a qualifying business deduction, reducing your tax bill. Taking on manageable debt can also help you build your business credit score.
#4: Create an Emergency Fund
Every business should have an emergency fund. This is an account reserved for unexpected costs or purchases. A good rule of thumb is that you should have six months’ worth of operating expenses in your emergency fund reserved for a rainy day.
Figuring out the dollar amount of your emergency fund can be done by analyzing your profit and loss statement. Pull the past six months of data and figure out how much money you spent. Keep in mind that this number can change based on your accounting method, prepaid expenses, and accrued items, which is why working with an accountant is advised.
Next, you will want to set a budget to generate excess cash flow for your emergency fund. Make your budget reasonable. For example, you shouldn’t try and decrease expenses by 20%. Instead, pick two or three categories that you want to focus on. This makes your goal more manageable and doesn’t place unnecessary restrictions on your cash flow.
#5: Plan for Expenses
Managing your cash flow takes planning. Whether this includes monitoring a monthly budget or saving up for a new equipment purchase, you need to have strategic operational and financial goals to keep your cash flow in check.
Make a list of your upcoming costs. This could include payroll, new equipment, a larger material order, moving into a warehouse, or offering a new product. Then, determine how much cash you need to be able to meet that obligation. Do you have enough cash on hand or do you need to utilize debt funding and budgeting?
Transparency into your financial situation can help you pay those larger expenses without compromising the financial health and stability of your operations. Remember that you can’t plan for everything. Having unexpected expenses is inevitable when running a business.
Which of these five golden rules are already implemented in your business? Effective cash flow management looks different for every business. This makes it important to understand which strategies work best for your business. Maybe you are struggling to receive customer payments or are unsure which financing methods are right for your business. Whatever the case, obtaining expert help might be the solution.
Our team at Craib Accounting can help you determine which cash flow strategies make sense for your business, allowing you to see tangible results in cash flow and profitability. Reach out today to set up a consultation with one of our team members.