Cash flow is the blood that drives business, and most small companies experience difficulties in this matter at some point. To understand the magnitude of the problem, 4 out of 5 companies report liquidity risk. Even the giant Tesla almost went bankrupt in 2008 and was saved at the last minute through a cash investment by Daimler.
Small businesses have cash-flow struggles due to insufficient planning, small capital stocks, and loose contractual terms with customers. Managers or owners should work together with their accountants or financial advisors and compute various cash flow ratios to assess financial health.
Cash Flow Forecasting
The first step you have to take as a business owner to avoid running out of liquidity is to plan. Think ahead and evaluate the money you want to spend and the amounts you expect to receive. Make a well-thought schedule for a year in advance, taking into consideration seasonal variations. Furthermore, break down the plan in quarterly, monthly and even weekly forecasts. Compare values with past records or industry standards for relevance.
Try to anticipate changes in the market, changes in your clients’ behaviors and possible shortages. Forecasting is not guessing, is putting data to work for you and taking educated decisions based on results. Remaining conservative or even a bit pessimistic helps you to avoid a liquidity crisis.
Ultimately, cash flow is the difference between accounts receivables and accounts payables. Organizing your payables is easy because it depends 100% on your abilities. The most important items to take into consideration are your scalable expenses, including baseline spending, inventory, and the gross margin to avoid running on empty.
Accounts receivables are the root cause of most liquidity struggles. Your duty as a manager is to create a predictable income flow. The solution is to be thought and creative at the same time. Offer discounts but put in place late payment penalties. Don’t be afraid to run credit checks on new customers as a protective method. Enroll the help of banks or specialized institutions for delinquent payments and discontinue service after 30 days late.
In an ideal setting, you should have enough cash to continue operations for the next 90 days, even if your largest account would default. This state can be achieved by careful planning of payments, taking into consideration contractual terms of suppliers and clients and using automation. Match the receivables with payables as you strive to save at least a small amount every time.
If you need a cash flow influx, you should carefully consider the available options. Most small business owners use credit lines, loans or even giving up some equity. However, there is the possibility of using your contracts and accounts receivables as a warranty at the bank, rather than taking credit. This action gives you the ability to pay your debts until the money rolls in from the client.
In conclusion, we have put together an infographic about the most common mistakes related to cash flow management. The piece contains suggestions of possible solutions to each obstacle and some relevant statistics. Hopefully, this will help your business avoid payment default and build a healthy and fulfilling relationship with clients.