Cash flow management: 5 mistakes to avoid to stay financially fit
Finance is rarely the most exciting part of being an entrepreneur, but it is the part that keeps your business alive. Poor cash flow management is one of the most common culprits behind small business failure.
It goes without saying that a business won’t be able to operate for long without cash in the business account. Here’s what you need to know to start managing cash flow wisely and give your business the best chance to succeed.
What is cash flow?
Cash flow refers to the amount of money going in and out of your business during a defined period of time.
Positive cash flow indicates your business is financially fit. More money is entering your business than leaving it, which means you have more than enough cash to pay off lenders, suppliers, and any other parties owed.
Negative cash flow isn’t always a bad thing. Startups have a negative cash flow since they often need to make large purchases (like equipment and inventory) before they can launch their businesses. However, if your business continues to have poor cash flow in the long term, this means money is consistently leaving your business faster than it’s coming in—which isn’t sustainable.
As such, cash flow management is of utmost importance. When you keep a close eye on how cash is flowing in and out of your business, you won’t miss key indicators of business failure or business growth.
5 common cash flow problems and how to avoid them
While the concept of cash flow is fairly simple, keeping your cash flow positive is easier said than done. Here are five common cash flow problems that small business owners run into and how to avoid them.
1. Not monitoring cash flow
One of the most common cash flow management mistakes is not keeping an eye on your cash flow in the first place. If you’re spending and earning blindly, you won’t spot early signs that your cash flow is going negative.
The easiest way to monitor your cash flow is by using accounting software, which small business owners can subscribe to for as little as $10 per month. Popular options, such as Xero and QuickBooks, automate the cash inflow and outflow tracking process by linking straight to your credit card and bank accounts. They also generate free cash flow statements so you get the full picture of your cash flow for any recorded date range—no need to create your own spreadsheets.
If you contract out your financial management tasks to an accountant, you likely won’t need your own accounting software. Your accountant can provide cash flow statements along with other helpful financial documents, including balance sheets and profit and loss statements. Many can even help you create cash flow projections based on your current cash outflows and inflows. Accurate forecasting can show you if your financial health is stable or if you need to rework your business plan to have enough money to operate and grow.
2. Not following up on receivables
Your accounts receivable includes all monies owed to your business. If you send invoices to your customers—instead of receiving payments on the spot like most retailers and ecommerce businesses—your receivables can make a big difference in your cash flow.
As a business owner, it’s your responsibility to make sure your clients pay you on time. Not following up on overdue invoices—or not setting due dates at all—can quickly lead to overspending or not having enough cash to operate.
There are a few actions you can take to avoid this cash flow management mistake. First, set clear payment terms on all your contracts and invoices. For example, you might require payment within 30 days of an invoice being sent. You can even offer small early payment incentives, like a waived fee or a 5% discount.
Second, use your accounting software to automate invoice reminders for your clients. This way, you proactively nudge them to make payments in time. If a payment does come overdue, personally reach out to your clients to ensure you receive the cash your business needs as soon as possible.
Most popular accounting software products allow you to easily track your accounts receivable so you don’t forget to follow up.
3. Undervaluing your products or services
How you price a product or service can significantly impact your cash flow. While offering low, competitive pricing is a great way to attract new customers in the short term, it’s not sustainable for every business in the long run.
For example, if you run a nail salon that uses high-end polishes, it likely won’t make sense to charge $30 per manicure just to compete with nearby salons—especially if your monthly earnings barely cover your expenditures.
When setting your prices and rates, consider how many sales you make each month and what your average expenses are. This will help you avoid a negative cash flow while ensuring you’re paid fairly for the value you provide.
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4. Confusing profit and revenue
It’s easy to look at your revenue—the amount you earn from selling your products or services—and assume your business is doing great. If your small business is making $500,000 in revenue each year, it certainly looks good. But having revenue doesn’t necessarily mean you’re making a significant profit. If you’re constantly spending $500,000 each year on products, salaries, and other operating costs, you won’t have any profit, and you won’t achieve positive cash flow.
High-profit margins are a far more important indicator of business growth. If you want to maintain your financial health, remember that revenue differs from profit and should always exceed your expenses.
As you track your expenses, be hyper-aware of your accounts payable, which includes monies you owe. What credit card, line of credit, or other loan payments do you have coming up? Do you have unpaid invoices from suppliers? Not factoring in future expenses can easily lead to overspending.
5. Not maintaining a cash reserve
When discussing cash flow management, it often revolves around money coming into your business. However, the amount of cash that stays in your business matters just as much. A rainy day fund will keep your business in tip-top shape, even when the unexpected happens.
For example, if you own a commercial cleaning business, you could be faced with a major cash flow problem if your top client leaves and your industrial floor scrubber breaks down in one month. You could feel the impact of these blows for the rest of the quarter or longer.
But if you have a cash reserve to dip into, you’ll be able to buy yourself time to strategize—without borrowing any funds when you’re short on cash—and quickly get your cash flow back on track.
Excel in your cash flow management
Cash flow management can help you be proactive about your financial health and avoid one of the top reasons for small business failure. Monitoring your cash flow is a good first step. However, if you want to maintain a positive cash flow, you need to know what keeps your revenue high—including on-time payments from clients and proper pricing—as well as what expenses you need to cover.