Small businesses often face a common problem: managing finances. In particular, they struggle with their cash flow.
In fact, 61% (!) of small businesses struggle with their cash flow.
Entrepreneurs utilize innovation and problem-solving to make their businesses successful. However, if finances and cash flow are ignored, then businesses are doomed to fail.
Small businesses are not provided with the large budget that a large company has. Therefore, they must efficiently and properly manage their cash flow to ensure that their finances are in check and business stable.
In this article, we will define cash flow and discuss how to manage it in a small business.
What is cash flow?
Cash flow can be defined as the movement of cash into and out of a business. Sales and revenue represent inflow, or money being received, while expenses represent outflows, or money being sent out.
Positive cash flow means that a business is getting more money than it is sending out. On the other hand, negative cash flow means that a business is sending out more money than it is receiving.
Types of cash flow
There are three main types of cash flow: cash flow from investing, cash flow from financing, and cash flow from operations.
- Investing: Investing cash flow refers to cash generated from investment-related activities. These activities can include sales of assets or speculative assets.
- Financing: Financing cash flow showcases the movement of cash from the company to its investors and owners as well as how the cash is being used to fund the company.
- Operations: Operating cash flow refers to the money generated and used for a business’s normal operations. It is involved with the production and sale of goods.
Cash flow vs. profit
While cash flow and profit are very similar terms, there are distinct differences between them. Cash flow is the money that flows in and out of a business, while profit is the cash earned after all expenses are deducted.
Profit can showcase the immediate success of a business. On the other hand, cash flow can provide a more holistic view of a business’s financial situation.
Why is it important?
Small businesses constantly experience cash flow. In actively growing businesses, maintaining a positive cash flow is required for business growth. It allows your business to meet current financial obligations while planning for the future.
Proper cash flow offers businesses flexibility. It enables it to seize opportunities, as well as overcome financial hardship. Additionally, positive cash flow allows for stability. Your business can enjoy smooth day-to-day operations.
How to manage cash flow in a small business
Whether you are a small business or a large company, cash flow is extremely important. But how do you actually manage cash flow?
Here are 5 ways that small businesses can manage their cash flow:
- Schedule your payments
- Establish clear payment terms with clients
- Use technology to manage your cash flow
- Manage inventory and expenses
- Keep a cash reserve
1. Schedule your payments
Do not make the mistake of paying off everything at once. Scheduling payments allows businesses to plan for upcoming expenses while also making sure that there are sufficient funds to cover financial obligations.
Scheduling payments ensures that payments are sent in a timely manner while also not hindering business operations. Additionally, businesses can avoid late fees and penalties that may occur if they miss their payments.
This method of payment provides insights into exactly how much money is sent out and when. It can also build credibility with suppliers as you make consistent and timely payments.
Small businesses can leverage artificial intelligence (AI) to effectively make payments. This reduces the risk of human error and ensures that payments are made on time.
2. Establish clear payment terms with clients
Communicate with clients to establish clear payment terms beforehand. Payment terms can include charging fees for late payments or even offering incentives for payments made early.
When setting up payment terms with clients there are a few things to remember:
- Clearly define terms and make sure there are no misunderstandings
- Allow customization and flexibility for each client
- Request upfront deposits
- Utilize consistent communication with the client
Establishing payment terms with clients helps to maintain a stable cash flow. It ensures timely and predictable cash inflows that can prevent cash shortages.
3. Use technology to manage your cash flow
We have already mentioned that you can use AI to assist your business in making timely payments, but technology can be used for various other things.
Technology can be a robust tool for managing cash flow in a small business, resulting in more efficient processes that allow businesses to use their time and resources for other tasks. For example, you can utilize ChatGPT to generate reports and summaries of your company’s finances.
Businesses can embrace digital payment solutions, such as PayPal, to accelerate payment processes. Additionally, businesses can leverage data analysis tools to interpret their cash flow patterns.
4. Manage inventory and expenses
One of the most effective ways of managing cash flow is to improve inventory management. Sell your inventory quickly to maximize the amount of available cash in your business.
Small businesses should also aim to avoid purchasing excess stock so that they are not stuck with an abundance of products that they can’t sell in a timely manner. Focus on monitoring your inventory regularly and ensure that you have a proper amount of product to sell.
Another important thing to pay attention to is your expenses. Controlling expenses is essential for proper cash flow.
Look for opportunities to reduce costs without cutting quality. Get rid of unnecessary expenses. Negotiate existing payment terms. These are opportunities to manage expenses (or cash outflows).
5. Keep a cash reserve
Life is unpredictable. You don’t know what will happen in a year, a month, or even tomorrow. That’s why keeping a cash reserve is important.
Cash reserves are funds that are set aside to be used for emergency situations. They are essential for financial security, especially at times when cash inflow is low or when cash outflow is high.
Cash reserves can offer peace of mind when times are rough and entrepreneurs are prone to financial stress. It also helps to avoid unnecessary debt.
Small businesses should pay close attention to their cash flow and take steps to effectively manage it. This will spur business growth and keep their finances in check.
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