Cash Flow management is one of the main challenges for small businesses. Proper budgeting skills can forecast cash flow 15-30 days out. In this article, we will discuss what cash flow is, common problems, and solutions to understand better and manage cash flow.
Cash Flow is the flow of usable cash for purchases/business operations. The management of money coming in and money going out. Every business is going to have a product or service to sell and generate cash. Retrospectively, every business will have some costs to produce the product or service they sell. As simple as it may sound, often, companies find themselves unable to make payments or accounts payable because they do not have the cash to pay it right now. This article will discuss the main areas that commonly affect Cash Flow (CF) and solutions to these problems.
Accounts Receivable
Problem
Accounts receivable are the money people owe you for purchasing your product or service. If you’ve ever heard the term “cash is king,” you may understand it from a business perspective. The quicker you get paid for your product or service, the better. Often, companies give their clients or customers invoices with a set period to pay for their product/service, or they extend credit. For instance, say you own a Lawn Care company, and you’ve completed your first lawn and invoiced the clients a bill for $100 due within the next 15 days. You were hoping they would pay you in 5 days because that’s when your bill is due for the loan you took out to buy all your lawnmowers. The client forgets to pay you until the 16th day (after a friendly reminder that their bill is due), but you are now scrambling to pay your lawnmower loan. This may sound like a silly mistake, but, in reality, it happens more than you’d think.
Solution
So, what can you do to prevent your new lawn mowing company from going under? Here are a few suggestions taken from the Pros:
- Negotiate the terms of your contract with clients
- Pay up-front or directly after service is performed.
- Decrease the amount of time the bill is due.
- Late fees (last resort.)
- Set up monthly direct deposit to accounts receivable
Most recurring home service companies go this route. Before lawn service, have your clients sign up for a monthly subscription. That way, you know exactly how much you are getting paid, from whom, and when.
- Increase prices
If you find that you are still scrambling with your cash flow management, it may indicate that you need to increase the price of your lawn service to make up for the lost cost.
Inventory
Problem
Inventory is another excellent example of how businesses are in a cash flow management scramble. For this problem-example, we’ll use a widget manufacturer to explain. Let’s say you opened a small business making and selling widgets to retailers. You found a retailer who loves your widget and wants to buy 1,000 of them from you to sell at their store. O.K. great! You’ve done the math, and it costs you $2.00 to make each widget, and you sell it to the retailer at a wholesale price of $4.00, and they sell it for a retail price of $8.00 a widget. But wait, if you make 2,000 widgets, the price goes down to $1.75 per widget. You figure this is the better deal. Now you have 2,000 widgets, and you’re out $3,500 when you were initially supposed to have 1,000 widgets and be down $2,000. Bills start rolling in, and you’ve sold 200 widgets, and 30 of them had to be returned because of malfunctions. You now have more widgets than you can sell and are scrambling to pay your bills.
Solution
- Slow Down
Although the bulk option may seem more appealing because the price per widget cost goes down, you still don’t know how your widgets will do on the market. Take it slow, and don’t create more inventory than you can sell immediately. These costs add up and can come back to bite you.
- Plan for damages/malfunctions
It would be best never to assume that every widget that sells at the retailer will function correctly (as much as you’d like to think your widget is the best); technology does fail. You must budget for these returns in advance, even if that means accounting for more malfunctions than actuality in the beginning. Better safe than sorry. By the time you’re up and running the largest widget factory in the world, this type of forecasting will become easier.
- Know your retailer’s terms
- Where the items are being displayed in the store.
- How quickly do they pay you when you invoice them for your widgets?
- What do they charge for damages/malfunctions?
Accounts Payable
Problem
Sometimes, events happen in life that cause an unforeseeable decrease in sales, and you are short of paying your vendors. For this example, we’ll use a restaurant. Let’s say you’ve been in business for years, sales have been good, and you’ve always paid your vendors on time. There’s a storm that lasts for about a week, severely hurting your restaurant’s sales and causing you to scramble to pay your meat and vegetable vendors. Typically, you pay them when they deliver the food to your doorstep, but today, when they come, you are short the cash to pay them.
Solution
- Negotiate with your vendors
Vendors typically will negotiate terms of payment, whereas banks do not. Instead of whipping out your rainy day (literally) credit card with outrageous interest rates, talk to your vendor first. See if you can negotiate the terms of your payment. Chances are, if you’ve been a loyal customer for several years and have always made timely payments, your vendor will let you extend your payment period.
- Make sure you have enough equity to cover your costs.
This would be the “rainy day” example. Life happens, and sometimes businesses take a hit. Although you can’t prepare for when your business will take a hit, you can be prepared for when it happens.
Budget
The goal for any profitable business is to have more money coming in than coming out. You always want to make sure you’re making more than you spend. This is what a well-maintained budget is for. You can forecast cash flow out 15-30 days in advance by maintaining accurate bookkeeping. But, when life happens, and you temporarily spend more than you are making, ensure the cash deficiency is covered by equity or available debt. Before you run to your credit cards, ensure that the debt + interest < the return on the investment. In conclusion, understanding your budget is always the best defense.
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