Many small business owners tend to gauge the health and success of their business on things such as profit margins, sales growth or strong customer loyalty. While these are critical metrics, the reality is that balanced cash flow is an equally important indicator of well being because cash pays the monthly bills, covers the payroll, and can be invested back into the company.
To help avoid the perils of uneven cash flow, simply keep these five basics in mind.
1) Know where you stand
Poring over an income statement alone won’t shed light on a company’s cash flow situation. Income statements only reveal sales, expenses, and profits at a given moment. A cash flow statement, however, shows the movement of money in and out of a business over a specific period of time, whether a week, month, quarter, or year.
A cash flow statement can show not only what cash is left at the end of the month but also the amount that entered and left the business. In other words, it can make it easier to see whether you’re adding to your business’s reserves over time or slowly eroding them. If tracking cash flow seems daunting, then take the time to speak with a savvy advisor. There’s no replacing the knowledge you can gain from these basic figures and calculations.
2) Go to the source
Cash flow problems can arise from either end of the business cycle – spending or receiving. At the spending side of the equation, businesses spend on a variety of operational costs, such as electricity, cleaning personnel, phone and Internet connections and even renovations or repair. Consider periods of growth, when a company needs to invest in inventory and infrastructure to thrive. Growth expenditures can quickly deplete precious cash reserves.
On the other side of the ledger, there must be a steady flow of cash coming into the business or reserves will quickly run dry. Slow business can erode cash quickly, so be sure to plan for the unexpected. Understanding where cash flow problems originate can help you avoid them before they become an issue.
3) Keep cash flowing
To help prevent cash flow problems, minimize your business’s fixed expenses. A company should be big enough to cover only its most predictable, recurring needs. Find creative ways of handling peaks in demand without hiring additional staff, such as outsourcing certain jobs or hiring interns or temporary help in busy periods. Or, if you feel you need to move to a larger and more costly space, consider sharing a portion of the space with another business.
Also, look for non-cash ways to make purchases, such as with credit-card rewards programs and frequent-flier points. Bartering with other businesses for products or services may be another option. For expenses that must be paid in cash, you may be able to even out cash flow by delaying payment through trade terms with vendors.
For the cash coming into your business, make sure what you’re owed arrives on time by setting clear payment terms and expectations. If you extend credit to customers, be sure to make terms clear, and consider discounts for prepayment and appropriate penalties for late payment. And don’t neglect good follow-up and collections.
4) Have a fallback plan
There still may be times when your company needs extra cash, so be prepared with several sources of financing in advance. Some financial institutions may be more likely to extend lines of credit or loans to your company when it is in good financial health and less likely when cash-flow problems have already taken a toll.
Once you have credit available to you, be sure to use it wisely. Short-term financing options such as lines of credit, short-term loans or credit cards are best used for short-term cash needs. Likewise, long-term or secured loans should be used for the purchase of long-term investments.
5) Manage growth
When growth opportunities arise, plan carefully with an eye on cash flow projections. Decide how much you have to spend to reach your goal and how long it will be before you pay back the debt.
Every investment, whether in inventory, people or equipment, should have a clear return. Make sure each investment earns a profit, but also look at how long it will take to collect them. Likewise, if you look at each customer as an investment with a scheduled return, you cannot only help improve cash flow, but profitability, too.
Richard Flynn is Senior Vice President and General Manager for American Express OPEN, the nation's leading issuer of small business card products.