Anyone that has built and maintained a small business knows that although maximizing profits is the end goal, it is access to cash that keeps the business operating. Implementing effective cash flow management strategies is how small business owners ensure access to adequate amounts of working capital. Disregarding cash flow management is the best way to invite financial trouble and increase overall business risk. On the flip side, maintaining a consistent, quality earnings stream is the best way to build your company’s market reputation as a stabile credit worthy business.
Cash flow management takes many different forms. On the revenue side it may mean giving customers a prompt payment discount or selling receivables to a factoring company that will take on the collection risk. Using these methods you will give up a small fraction of your invoice values to get quick or even immediate access to your cash. On the expense side the decision may be how long to delay paying credit invoices (an interest free loan from your vendors), or whether to reduce the purchase of non critical goods and services.
Regardless of which method you eventually use to increase profits, making these operating decisions will require a thorough understanding of the business and a high-quality forecast model. Running a forecast using different scenarios will demonstrate the effect of these different strategies on cash flow. It will provide a cost benefit analysis and hopefully indicate where the business may run into financial troubles in the future. The goal of cash flow management is to make sure that the company is always generating enough cash or has enough working capital on hand to cover any unforeseen financial risks.
By searching the internet, small business owners should be able to find low cost, and in some cases free, tool to help them investigate and fine-tune their firm’s net operating income. Nathan Shackles, sales director for Racarie Software, sells a program called ApplicantStack to the human resources industry. His customers have unique cash management issues, since their predominant revenue comes from monthly service fees that they may not collect for several months. For this reason, these companies focus on a customer’s lifetime value as well as the monthly fees that it collects from them.
“A typical customer’s lifetime value may be $1,000 but our monthly cash flow from that customer is only $70,” Shackles says. “So our cost to acquire new customers [advertising, marketing, commissions, etc.] is significantly higher than the revenue we collect from them the first few months.”
To motivate customers to accelerate payments, shackles implemented a prompt-pay plan that provided customers with a 15% discount for paying for at least three months of services upfront. He says, “It lowers my gross revenue a little, but helps cash flow tremendously by front-loading the acquisition of cash.”
Build Cash Reserves
“Cash flow is like oxygen, without it, a business will die,” says Mark Kleszczewski, the chief executive officer of GoBusiness Group, a management consulting firm. Because of its importance to the business, cash flow management is a necessary management tool, whether a company has adequate cash reserves or whether it needs a cash infusion to survive. Understanding your needs and your options allows you to make the right decisions for your business. Not trying to estimate your firm’s periodic cash flows, and trying to settle financial issues as they occur, means taking on those financial risks that might have been avoided.
Julie Murphy Casserly, is a wealth management adviser and the author of The Emotion Behind Money, according to her, “Today is the time for owners to get really clear as to what their true business priorities are and create financial space in their cash flows. Items and expenses that were important two years ago may not have the same priority now.”
She recommends that small business owners ask themselves appropriate questions like “Does this expense support my dreams, desires, and business plans for the future?" If the expense is not critical to operating the business and does not directly aid in achieving business goals then use that freed up money to build up working capital and cash reserves. Having enough cash built up to cover a year’s worth of operations including payroll can significantly reduce the stresses of owning a business. Having an adequate amount of cash to cover any unforeseen financial problems, allows owners to deal with issues calmly and rationally if and when they arise.
Planning for problems
By planning for potential financial issues, owners are more likely to avoid significant ups and downs in operating income. Since income volatility is how the market measures business risk, having unstable cash flows may be perceived as resulting from an owner’s lack of control. Although this may not be an immediate issue, it can significantly impact a company when it asks for credit terms from a vendor or when applying for a bank loan. Depending on the commitment required from customers, clients may also prefer working with a business that is perceived to be more stable or to have less chance of becoming insolvent. The best way to build a market reputation as a quality, credit worthy enterprise is to perform cash flow management on a regular basis and to implement the appropriate strategies to keep your cash balances high and your cash flows consistent.