What is cash flow? Why is it so important? How can your business improve cash flow? Many people have a difficult time understanding the concept of cash flow. As a business owner, you definitely need to understand what cash flow is, why it’s important, and how you can maintain a healthy cash flow.
Cash is the lifeblood of a business. Without cash, it’s game over. Think about the game Monopoly. At the beginning of the game, each player receives a set amount of cash. Then, they move around the board purchasing property and making money off it. If a player makes the wrong choices or is simply unlucky (i.e. landing on the wrong spots), he or she can quickly run out of cash. Then, it’s game over. This is not entirely different from how a business runs. Without cash, how do you operate? How do you pay for the things you need to make your product/run your service? Well, you can’t. You can try taking out a loan at the bank, but the bank is also a business. It seldom wants to lend to a “high-risk” client that can’t manage its cash properly.
So what is cash flow? Cash flow is the movement of cash into and out of a business. To be successful or even to merely stay afloat, businesses must manage their cash flow properly. If they don’t, they usually run out of cash before they can pay their bills, leading to a cash shortage and a vicious cycle of debt.
To illustrate cash flow and its importance, let’s say that you’re a successful small business making $12,000 a month after taxes. Your expenses add up to $8,000 a month, so your profit is $4,000 per month. This might seem like a good thing, but you’re not taking into account your cash flow. Let’s say that all your bills are due at the beginning of the month. However, you don’t receive your income until the middle and end of the month in two installments. Well, you owe $8,000 at the beginning of the month, but you don’t have the money to pay your bills. You have a cash flow problem. Now let’s say you get $6,000 (half of your monthly $12,000 income) in the middle of the month. You can pay most of your bills off, except for $2,000. You have to wait until the end of the month to pay off that last bit and perhaps late fees. Although some businesses allow you to pay a late fee, most will not put up with a late-paying customer for long. You as a business are in serious trouble, even though you have a positive net profit. This is why you must manage your cash flow to keep from running out of cash at the very worst time. In other words, carefully watch the timing of when you pay out cash and when you receive it.
Now that you understand why cash flow is important to a business, how can you improve your own? We outline five easy ways to immediately improve your company’s cash flow below.
1. Review your financial reports.
The frequency of when you should review them depends on your company’s cash position. Companies that are cash-stressed should review their statements almost every day or at least once a week. Companies that have a better cash position can review their statements monthly or quarterly. What statements should you examine? Take a look at this list:
- Balance Sheet: This statement shows you what your company owns (assets) and what it owes (liabilities). Your assets consist of things like cash and accounts receivable (money that others owe you). Assets should always be higher than accounts payable, meaning that you own more than you owe.
- Income Statement: This statement shows you how much money you’re bringing in after expenses. Look at whether your operating profit has a high profit margin. It tells the story of how much cash you’re keeping (remember, profit and cash aren’t the same). If you’re not keeping enough cash, your expenses may be too high.
- Statement of Cash Flows: This statement is often overlooked by managers, but remember how we’ve stressed the importance of monitoring your cash flow. How did you use your cash? A statement of cash flows tells you through three sections. They are the operating (how you spent cash), financing (where you got your money, from loans or your own money), and investing (what cash you spent or generated from investing activities) sections.
- AR Aging Summary with Collection Notes: This statement contains information about the people who owe you and their status, whether they’re late, defaulted, etc.
- AP Aging Summary: This statement shows you all the people whom you owe and the status of your repayments.
- Cash Flow Projection: This should be updated daily or monthly. It shows you all the balances of your bank account and how much the accountant thinks will be in your bank account by the time the report comes out.
2. Fix your customer billing process.
This tip applies best to companies that render services to customers before receiving payment. Customers make a huge impact on cash flow because they’re paying with cash for your services. Customers who pay on time keep money flowing into your business. Customers who procrastinate on paying delay cash from moving into your bank account. However, by making the following improvements to your customer billing process, you can encourage customers to pay you back quicker.
- Pre-Sale Vetting: Conduct thorough background and credit checks to ensure that prospective customers fit your demographic and can afford payments.
- Customer Contracts: Your agreements need to clearly explain the penalties for late-payments and when they occur. Penalties can include fees or closed accounts after a certain period of nonpayment.
- Organized Paperwork: Your invoices shouldn’t leave out key information that your client needs to pay you. Nor should they be too difficult to read and understand. Don’t write out invoices using hard-to-read fonts or leave out important information such as correct billing amounts. To further simplify the customer experience, let them know the types of payments you accept, complete W9s and insurance documents, and have proof of a sales/purchase order. Customers don’t want to encounter difficulties while trying to pay you. In fact, they might put off paying you because they’re also busy and don’t want to spend the time dealing with your errors.
- Easy Payment Options: Make it easy for customers to pay by being flexible. Offer multiple payment options, such as wiring, cash, check, credit/debit, or bank ACH. Clearly explain what you do and don’t accept. People today want flexibility in how they can pay. Giving customers many payment options helps them pay you faster.
- Collections Processes: You need to have a clear process on how to follow up with clients who haven’t paid. Will you send email reminders, mailed letters or statements, or collection calls? When will you hire a collection agency? Set out clear timelines for when to take certain actions.
3. Stop the bleeding.
One of the hardest conversations that we have with clients is telling them that they need to cut expenses. Running a business is expensive, as you know. If you’re in serious financial straits, you have to look at the things that cost you the most and find ways to either minimize or eliminate them. Look at your top three expenses. Decide if the expenses can be canceled or outsourced to a cheaper source. Or, you might be able to renegotiate the payment terms. Sometimes you just have to admit that you can’t afford what you think is a “necessity” but is actually a luxury. That company car, first-rate office space, or secretary can be eliminated if it’s not bringing tangible business results to your company.
4. Find the “cash cow” of your business.
What is the one service/product that’s easiest to sell? Identify that product, then vamp up its sales before all other products and services. For example, think about Moe’s Southwest Grill’s biggest selling item. Is it burritos? Bowls? The answer is actually drinks! People order different kinds of entrees when they go to a restaurant, but they always order a drink. Restaurants can produce drinks for just a few cents, then turn around and sell them for $2 – $3 or more. And people will pay because nobody wants to choke down a burrito with no drink. That’s how restaurants discovered their cash cow. Find yours, and you’ll be bringing in a greater amount of cash.
5. Generate more sales!
Separate from finding the company’s cash cow, almost all cash flow concerns can be overcome when the business earns more money. Get the word out that your business offers something of value to people. Invest in activities such as marketing, advertising, hiring more sales personnel, running referral promotions, or partnering with other companies and sharing the profits. The key idea is investing in activities that grow your business, not wasting money on frivolous things. A good way to gauge whether you’re spending money on a valuable activity is asking yourself, “Does this activity help my business bring in more income?” Having the best office space in the building usually doesn’t generate income directly or indirectly. A well-crafted advertising campaign that increases your sales by 40% provides tangible business value. Make sure you always make this distinction when spending money on business activities.
Try some of these techniques today to improve your company’s cash flow. Or, consult with IQ Outsourced Accounting. We provide an entire accounting department in exchange for an affordable monthly rate. Among other benefits, we help you improve your company’s cash flow and business success. Call us at (770) 255 – 0935 or contact us to see how can help you.