Cash Flow Management Best Practices for Small Businesses

It doesn’t take running a business for very long before business owners realize that cash is their lifeblood. No business is safe from cash flow problems. Younger businesses can get into trouble by underestimating sales cycles, or receivable timeframes, or overestimating inventory. All businesses are susceptible to unexpected economic downturns or a cash crunch from a sudden growth spurt. Overcoming any of these challenges can be a challenge for businesses that fail to prioritize cash flow management.

Here are five best practices business owners can follow to ensure maximum success in their cash flow management.

Know Your Business Variables

Businesses with growth ambitions must be able to manage the many variables that impact the flow of cash in and out of the business. The true test of effective cash flow management is how the business reacts in the face of various variables – both expected and unexpected – that can impact cash flow at any time. It’s easy to prepare for some predictable patterns, such as seasonal shifts, inventory cycles, and monthly sales fluctuations, all of which can be incorporated into a 12-month cash flow projection.

However, there are many variables that can arise unexpectedly, such as new or increased competition, an unexpected business opportunity, the loss of a key employee, changes in vendor relationships, or the loss of a significant customer. Those are the reasons why it is essential to build a three to six-month cash reserve or have a reliable lending source in place. In addition, business owners should continually work on their relationships with vendors and customers, and stay attuned to the market’s pulse.

Anticipate the Future

A growing business will encounter critical junctures at various stages of growth, which can become obstacles without proper planning. Without a firm grasp of projected spending needs and cash flow, a business can encounter a cash crunch as it attempts to scale up to the next level. Many businesses rely on financing or investment to achieve their goals. However, lenders want to see that the business has been able to hit cash flow and profit milestones over a specified period. In anticipation of the need for capital, a business should manage cash flow based on a 12 to 24 month cash flow projection. The projection, along with a business plan, should be shared with a lender well in advance of the need for capital.

Monitor, Measure, and Adjust Frequently

Cash flow data should be monitored monthly to identify any problematic trends on both the revenue and expense sides. Key indicators, such as slowing receivables, erratic expenses, uneven payables, or increasing costs, will appear on the bottom line as either an anomaly or a trend. Monthly data should be compared against cash flow projection benchmarks. If a benchmark is not met, action should be taken to counter the deficit, or an adjustment should be made to the cash flow projection. Business owners should develop the habit of questioning their projections and their assumptions to ensure they do not overestimate inflows and underestimate outflows.

Optimize Receivables and Payables

The root of most cash flow problems lies with the ineffective management of receivables and payables. Businesses that allow receivables to stretch out past 30 days or lack control over their payables are likely to encounter cash flow problems. If allowed to persist over time, these problems can cripple a business. Businesses that focus on gaining control over their receivables and payables are better positioned to weather the unexpected.

For example, receivables can be accelerated by convincing their customers to pay with electronic funds transfer (EFT) or Automatic Clearing House (ACH) payments. The same technology enables businesses to optimize the timing of payables, ensuring that cash is not released until it is absolutely necessary. Cash management tools available through a business bank enable businesses to streamline their cash flow management processes, ensuring they maintain optimal cash flow.

Businesses can also negotiate more favorable payment terms with suppliers to better control their payables while clarifying invoice terms with customers to ensure more timely receivables.

Fortunately, business owners have access to numerous tools that can enhance their ability to manage cash flow. Accounting software programs can simplify even the most advanced tasks of small business bookkeeping and accounting. Cash management tools available through a business bank can streamline most of the payables and receivables functions through automated systems. All that is left for the business owner is to utilize the information these tools provide to make informed business decisions based on their data and focus on ways to enhance the bottom line.