Depending on the size of the business you run, cash flow management can be a non-issue, or it can make your life a living hell. Forty-three percent of small business owners claimed that cash flow issues were responsible for critical crises, such as being unable to pay employees on time.
The last thing you want to do is get caught up in a situation like that. In this article, we will look at what cash flow management exactly involves, why it can be so challenging, and how you can better prepare for it.
What Is Cash Flow?
The term “cash flow” is used to identify how much money is actually moving in and out of your business. The reason this term exists is that business owners often look at the raw numbers and believe everything is going fine. On the contrary, this may not always be the case.
Cash flow is an important metric that all business owners need to be aware of. It is important to note that cash flow is different from profit.
Here are three key components that make up cash flow management in a business:
1. Operational Activities
Let’s explain this in terms of owning a car dealership. Operational activities would include the money you earn from the sale of cars and the money you spend paying your employees. Of course, numerous other income and expense sources exist, but let’s keep it simple.
2. Investing Activities
If you took the money earned from car sales and upgraded the lighting in your dealership, that would count as an investing activity. It could also include any buying and selling of assets and investments. Sometimes, people spend more on investing activities than they have the means to. In such cases, you end up with a negative cash flow.
3. Financing Activities
Have you sold company stocks of your car dealership, paid dividends to shareholders, taken loans, or made debt repayments? If so, these are all examples of financing activities.
4. Aim for Positive Cash Flow
The relationship between the above cash flow activities can create either a positive or negative cash flow situation. Essentially, you want your business to have enough funds to cover all your obligations and expenditures.
There are times when negative cash flow is unavoidable. However, for the most part, you want to stay in a state of positive cash flow. Sounds easy, right? It’s not. Let’s look at why it can be challenging.
Why Is Cash Flow Management Challenging?
Even though the concept may be simple to understand, making cash flow work smoothly, in reality, is a different story. There are three reasons for this.
1. Timing Differences
Often, your inflow and outflow are not going to match perfectly. You may receive payments late and need to spend money earlier than expected. When this happens, it creates a cash flow gap. If you have been operating in a negative cash flow state, the situation becomes even more tricky to manage.
2. Seasonality of Funds
Experienced business owners are aware that revenue doesn’t stay uniform throughout the year. There are slow seasons when your inflow may not match your current needs. In such situations, you will have to budget and plan for dips in cash inflow.
3. Variable Expenses
Cash flow management is easy when you have a clear and concrete idea about your average income and expenses. However, running a business often involves variable expenses. The price of raw materials can fluctuate, utility bills can vary, and it can be tough to manage cash flow discrepancies on short notice.
What Strategies Can Be Used to Improve Cash Flow Management?
Thankfully, the subject of cash flow has been studied extensively by businesses around the world. As a result, there are several steps you can take to ensure cash flow doesn’t become a headache for you. Let’s look at some of them below.
1. Use Business Lines of Credit
If you choose to go this way, remember that building business credit takes months. It is not a strategy that you can implement overnight. That said, if you go about it the right way, you can effectively circumvent many of your cash flow issues. It allows you to cover sudden gaps without needing to take regular loans, which often come with annoying conditions.
According to Digital Honey, it might take you about a year to build a solid business credit profile. It takes this long because you need your business credit reports to show on-time payments for at least ten months.
2. Set Up Contingency Funds
Even if you happen to have a business line of credit, it is wise to maintain contingency funds. This is because you don’t want to make it a habit to rely on debt accumulation.
Lines of credit should not be something you keep taking advantage of. It casts a bad image on your business if you frequently need to use credit. Thus, contingency funds should be one of the first things you set up in your business.
3. Consider a Subscription Model
Subscription models are excellent for cash flow as the income is almost guaranteed if the client sets up automatic payments.
If you feel like your clients may not be motivated to switch to a subscription model, you can incentivize it. You can do so by offering exclusive services, discounts, bundled products or services, and satisfaction guarantees.
Conclusion
Hopefully, the information in this article has helped you gain some clarity into cash flow management. You can save yourself a world of headaches if you implement some of the strategies we discussed today.
As always, consult your financial advisor to understand what steps will provide the best results in your unique context.
