Cash flow management is vital for all businesses, especially when you are just starting. Most small businesses fail within their first year because they run out of cash to pay off their immediate expenses, even when their businesses are making profits. Once you know how much is your cash inflow and outflow, you can improve your business cash flow better. Here are 6 tips on how to manage your cash flow.
1. Find your breakeven point
A breakeven point is the point where your sales cover exactly your costs. It is important to know that you are pricing competitively while being able to cover your operational costs. It is also the simplest way to determine if your business is profitable or not.
To determine your breakeven point, you need to know 3 things:
- Fixed cost – costs that don’t fluctuate, such as rent or utility bills
- Variable cost per item – costs that are dependent on sales volume, such as production costs
- Selling price per item
The formula is simple:
Once you know where you break even, you can assess the true cost of your business operations and manage them. This makes it easier to set a reasonable sales target on how much profit you can make.
2. Maintain some cash reserves
Emergencies such as a breakdown in machinery or purchasing inventory in bulk for a big order require quick cash. When you have cash reserves, you won’t have to worry about the lack of money to continue your operations. It will also keep your business afloat during an economic slowdown. When it comes to how much you should set aside, the rule of thumb is to save up 3 to 6 months’ worth of expenses.
3. Have optimal working capital
Working capital is the money that covers costs and expenses while you wait for customers to pay up. It involves your current assets (e.g. cash, accounts receivables, inventory) and current liabilities (e.g. loans, accounts payables, expenses). The working capital formula is this:
Too little working capital, and you can’t buy your supplies and cover immediate costs. Whereas having too much increases operational costs and reduces efficiency. Therefore, it is important to strike that balance to pay off your short-term expenses while investing in the growth of your business.
4. Get your customers to pay ASAP
When it comes to making payments, customers tend to take their time, especially if you have a “net-30” or “due in 15 days” policy. Until they pay you, you don’t have cash flowing in and you don’t have enough working capital. So you have to encourage them to pay what they owe you ASAP. There are many ways to encourage faster payment, such as:
- Request a deposit before accepting an order – this increases cash flow and working capital without hurting your business.
- Send payment reminders – you can either automate your reminders or delegate a trusted team member to follow up on collecting customers’ payments.
- Offer early payment discounts to your customers – when you offer to save them money, they’ll be more likely to pay up quickly.
- Enforce a late payment penalty – since nobody likes to pay fees, this sends out a strong message to settle payments.
- Discuss payment terms – make sure your customers know from the beginning about your payment terms. Nobody likes to be surprised about being charged with a late payment fee or having to pay a 50% deposit upfront.
5. Get the best deal to extend your payables
On the other hand, you would want to extend your payables window as much as you can to have enough time to collect receivables and cover your costs without owing a lot of credit. Negotiate payment terms with your suppliers, but be sure to pay them on time. Staying on good terms with your suppliers is crucial as they are the lifeblood of your business.
6. Hire an Accountant
When your business grows, balancing the books can get complicated. You could do it yourself, but it is better to get a professional’s help to do the taxes and keep your books in order. You could either hire someone in or outsource the job to an independent firm. This way, you’re taking your mind off the books while you focus on bringing in sales. If you need a referral, you can check with your business colleagues, your banker, or the Society of Certified Public Accountants in your state.
Cash flow management is about putting your money to good use. It doesn’t have to be hard. Over time, your cash flow management system will become part of your business’ financial planning, and you will be a pro at it.