How important is cash flow management for small businesses?
Posted on March 6, 2015 by Nikki Lane
Cash flow management is critical for small businesses, and it’s an area of management too many business owners overlook until it’s too late.
Almost half of small businesses starting up in Australia fail. The Australian Bureau of Statistics found 42% of small businesses fail in their first few years and a recent study of 2,200 small businesses in the United States found 68% of those business owners conducted absolutely no cash flow management.
This matches my experience of working with small business owners. Far too many of them don’t understand that cash flow is the make-or-break factor for their business. This is especially true for small businesses moving out of the start-up phase into the growth phase, as success means stock, expenses and receivables can easily increase faster than profits can fund them. The resulting cash crisis can force an entrepreneur to lose equity control of the business, or ultimately declare bankruptcy and close.
What are some common cash flow management mistakes small businesses make?
There are many cash flow management mistakes that small business make, including mistaking profit as cash flow, not understanding the lag time in a cash flow cycle and sloppy management of invoices, stock, and credit (both your own and extending to customers).
One of the biggest mistakes small business owners make is being afraid to ask their accountant questions. It’s not uncommon for small business owners to go over their budget, or fail to budget entirely, and than feel too guilty to discuss that with a mentor or accountant until the situation improves. It may not improve without a smart intervention.
What can small businesses do to ensure they manage their cash flow effectively?
Small business owners must create a current and realistic financial business plan, budget and forecast. This may mean investing in a financial consultant, but the parameters and guidance you’ll get from the plan are worth it.
Once the plan is in place, businesses need to set up a schedule to ensure they continually monitor their business against this plan. A to-do note is not enough; they need to block the time out in their planners for the next twelve months and stick to it.
Small business owners should consider creating a more structured approach to their invoicing. This includes systems for getting invoices out quickly, implementing realistic (usually shorter) payment terms for customers, and systems for following up on overdue debts. Some business owners may even offer a small discount for invoices that are paid quickly or better yet ask for payment up front or at least a deposit.
They need to think about how they’re charging their customers and whether or not they are asking the correct price, I see many small business owners underestimate the value of their service.
Business owners can also take steps to minimise their costs such as ordering less stock, more often. Another way to reduce expenses both immediately and in the long run is to lease rather than buy equipment, as they won’t have to pay to maintain often-expensive machines.
If businesses have a surplus of cash coming through, should they spend it on business development and marketing, or save it for tighter economic times?
If small business owners find they have a surplus of cash coming through their business, they should revisit their financial plan. Make sure they are accounting for all the essentials of a growing business, including business development and marketing. Marketing is not an optional expense. If they stop marketing their small business they will run out of customers – it is an ongoing balancing act.
I encourage small business owners to not forget to pay themselves a market-based wage for the work they are doing, as this will help maintain boundaries between their business and personal life.
If a small business does accumulate a surplus of cash, I recommend they park the money in a high interest savings account that is linked to their day-to-day account for quick, easy access. Having surplus cash saved is reassuring to lenders and investors, and also for their own sanity.
Another investment a business owner can make with excess cash flow is to eliminate personal debt and build assets outside of the business. But they need to remember not to leave their business short on cash to do this.
What advice would you give to new small business operators looking to manage their cash flow and grow their bottom line?
Take your cash flow seriously. Read up on it if you’re not sure exactly what it is and how it works. The government’s free small business website www.smallbiz.nsw.gov.au is a great place to start.
Find and hire a reliable and switched-on accountant who understands small business cash flow. Invest the time and money into developing a relationship with their accountant, and their business financial plan so they are on the same page and have the same plans for cash flow.
Schedule the time now for a weekly (or minimum monthly) cash flow check against their financial plan. Don’t expect to remember this in the busy everyday mayhem of running their business. They should also schedule in an hour every fortnight to read up on what’s happening in the market, to see if there are trends or external happenings they need to be aware of.
Find out how to be flexible, and learn to adjust. Notice when their finances are tracking the wrong way, and work out how they can turn that around. This is where networking can be very valuable; connect with other small business owners who can offer you on-the-ground advice.