Free money is good. Good for your business’ long-term sustainability. Good for its financial performance. Good to grow on. But if you’re tempted to start searching for instructions on how to claim gifted greenbacks, stay with us. Because this isn’t about a windfall.
It’s about an amount of money that’s not held hostage by delinquent payments, tied up in outdated business operations or imprisoned in slow-selling inventory. We’re talking about money that’s free to move. Free to go toward opening new locations, taking on bigger jobs, building your brand, attracting more customers or even courting investors.
Ensuring you have enough liberated dough on hand requires effectively managing your cash flow. But that’s not all. It helps to adopt an agile mindset around what cash flow actually is. And the knowledge that day-to-day decisions made across your organization affect it more than you think.
Read on to learn:
What is cash flow?
While the idea of cash flow seems pretty straightforward, it helps to understand it through the perspective and language of finance. We’ll break down the practical elements of cash flow, how they’re related to one another and why they’re all important.
Cash and cash equivalents (CCEs)
Cash refers to the money that belongs to your business. That can take the form of physical currency that’s kept in petty cash or other on-premise areas, like a safe. It also refers to money in savings or checking accounts.
Cash equivalents refers to anything that can be turned into cash quickly, like treasury bills, notes or money market funds. CCEs are the building blocks of cash flow.
Cash flow
Cash flow is the movement of CCEs through your business in the forms of cash inflows and cash outflows. As you can probably guess, cash inflows occur when money comes into your business as a result of selling your product or service, or securing a business loan or investment. Cash outflows describe money that’s leaving your business. Most cash outflows include expenses like rent, payroll, taxes, interest and business-related purchases. It’s like the credits and debits you see in your own personal bank account.
Achieving positive cash flow in your small business — essentially making more money than you’re spending — is the goal. Using a cash flow statement will help you get there.
Cash flow statement
If cash inflows and outflows are like credits and debits, then the cash flow statement is like a checkbook register. It helps you understand the amount of CCEs you have, which in turn informs the decisions you make around spending, saving and much, much more (we’ll get into that later).
A simple statement consists of three sections: operating, investing and financing activities.
Operational activities refer to any cash inflows or outflows that are related to the running of your business, and include short-term investments. Sales, payments, payroll, rent and utility bills are just a few items that would be considered operational.
Investing and financing activities describe the banking side of the business and include decisions about long-term investments. Investing activities can include buying or selling an asset, like a building or major piece of equipment. Financing activities cover obtaining a loan or paying a debt.
Each section shows the cash inflow and outflow amount for the activities that fall within that section. Those amounts are then combined into an overall amount of cash or cash balance: a form of working capital. Working capital describes assets you can quickly put to work, and are a crucial measure of your business’ financial health and stability.
How is cash flow different from P&L?
Since we’re on the subject of lingo, it’s important to make a distinction: While it may be tempting to sub your profit and loss statement (P&L) in for your cash flow statement, you may want to rethink it. Because when done properly, these two statements are two separate tools that reveal different aspects of your business’ financial health.
Your P&L should show how revenue becomes net profit or net income, after all expenses or expenditures have been deducted. It’s an indication of how profitable you are, or how much money you made. The cash flow statement essentially reveals how money moved in and out of your business to contribute to profit and loss. To truly understand the financial state of your business, you need both: the P&L figures that give you the what and the contextual detail from the cash flow statement that explains the why.
Positive cash flow puts you in the driver’s seat
Achieving positive cash flow isn’t necessarily easy. At first, it can be a sheer matter of survival. But once you’re consistent, it’s important to start thinking about how your cash can work for you as soon as you can.
Remember: Part of cash’s value is that it’s free to move. When you have a healthy amount on hand, you may want to start thinking about your growth strategy. With enough cash, you can purchase what you need when you need it, without having to rely on loans or debt. And that can make a big difference. When it comes to getting loans, small businesses can face an uphill battle because they are often seen as riskier ventures than their larger counterparts.
Cash gives you the freedom to move forward quickly, without having to jump through a lot of hoops.
On the other hand, if you decide to pursue financing for the next stage in your business’ evolution, more cash could give you more negotiating power. Positive cash flow isn’t just a measure you use to understand the financial health of your business. Lenders and potential investors will be interested as well. When they see a positive cash flow, they may be more inclined to offer you better interest rates or bigger capital investments.
Tips for managing cash flow
So how do you get there? In addition to keeping an eye on cash flow with a cash flow statement, you’ll need to take practical actions in bookkeeping and across your business:
Accounts receivable (A/R)
Let’s start with the “money in” function of your business and steps you can take to increase the chances you will get paid on time.
Start by setting a firm policy around payments, credit and collections. Make sure that your customers know your payment terms, including whether they need to pay in-full, upfront at the time of service, or if you’re willing to extend a line of credit in the form of a delayed payment agreement. When setting your policy, you may want to consider exceptions for certain customers. If you do, it’s important customers understand those terms as well, in addition to what to expect should they fall behind.
A lot of small businesses use a tiered collections process, in which different actions correspond to specific late-payment periods. For example, if a customer is 15 days late, they may receive a gentle reminder from a sales person. At the 30-day mark, perhaps a letter from the bookkeeper or owner. Sixty days may bring a call and a notice that their account will be sent to collections.
While it’s important to set this policy, train your employees and apply it as consistently as possible, you may also want to allow exceptions. Make sure employees know what type of situations qualify for a deviation from the process. You may also want to require your team to obtain approval from management before they can offer alternatives.
Lastly, consider paperless billing. Shoring up A/R can only help so much if you’re sinking money and time into an outdated billing and invoicing process. Don’t tie up cash in envelopes, paper, printing, postage and the salary you pay someone to do it all. Give your customers the opportunity to pay electronically with credit cards or other forms of digital payments. Not only is it less expensive, it can help you get paid faster. And that will always be a good thing, especially when it comes to generating positive cash flow.
Accounts payable (A/P)
So what about when the shoe is on the other foot? If you’re purchasing something, shouldn’t you pay quickly, since that’s what you want your customers to do?
Not necessarily. Experts recommend holding onto your money for as long as possible. That means paying your bills on time, as opposed to making an early payment. As a small business owner, it’s crucial your bookkeeper knows this. It’s also important you frame it as a policy and not a preference.
It can also mean negotiating credit terms for yourself. When doing so, go for the gusto whenever you can. Some businesses allow as much as 90- or even 120-day credit terms for customers in good standing.
Inventory
Any discussion about cash flow would be incomplete without inventory, because that’s where a lot of cash can go to die if you’re not managing it well.
Don’t get us wrong: Inventory counts as an asset. But if it’s not being converted into cash fast enough, cash flow issues could surface. When faced with this scenario, a lot of small businesses are tempted to cut inventory and refrain from buying anything new until they sell the items they have. But that may not necessarily be the best move. Sure, you’re not seeing cash outflows in terms of purchasing products. But you could be creating a shortage on some of your most popular items, which sets you up for a sales slump in the future. So what’s the answer? Data, data, data.
Look to your POS system for the information you need to eliminate shortages and prevent overbuying. The right one should make it easy to keep an eye on your inventory across different locations in real time. With one login, you should be able to see what’s selling and where, and transfer unlimited SKUs between locations.
Information is increasingly at the heart of strategic financial decisions for businesses of all sizes, in almost every industry. Make sure that your POS system can deliver what you need in terms of reporting, and give you the freedom to slice and dice the data however you need to.
Sales and discounts
Running sales to get rid of excess out-of-season inventory is a natural part of some businesses’ annual cycles. And sometimes to close a deal or even resolve a conflict, your employees need to offer discounts. Doing it all strategically is part of achieving positive cash flow.
This is another area in which establishing, sharing and upholding a policy can be helpful.
You don’t want employees to give away the farm, but it’s important they have the autonomy to offer sales and discounts.
One way to do this is by using the retail price and the price at which you’ll take a loss to set a figurative perimeter. Inside the perimeter, your employees can do whatever they need to get the deal or appease a customer. Should they want to go outside of it – for a single item, a total ticket value or however you decide to structure it – approval would be required.
Labor costs
You may be surprised to see this pop up since labor is typically considered a fixed cost. However, in the daily flow of work, you could be losing cash in surprising ways.
Overtime: When you pay employees time and a half, you are essentially paying them at a premium rate. Are those employees doing a premium job on tasks that will really move the needle for your business? Or is that premium rate paid haphazardly, to whomever decides to earn it doing whatever they do?
Payroll and HR technology can help you keep an eye on your overtime costs and even alert you to employees who may be approaching the threshold. It can be an important tool toward eliminating unplanned overtime.
Time theft: Time theft is a form of attendance fraud and unfortunately, it’s pretty common.
Up to 19% of employees report engaging in some form of time theft – which can include fraudulent timesheet entries or buddy punching – with the average employee stealing up to 4.5 hours every week.
To stem the tide, it helps to use PIN-punch or facial recognition time clock software, which makes it tough for employees to submit false information for themselves or one another.
Even though we’re talking about hidden or unplanned cash outflows, we would be remiss if we didn’t mention a surprising cash inflow that may be available to you. The Work Opportunity Tax Credit allows employers to earn anywhere between $2,400 and $9,600 per year, per new hire that comes from designated groups.
Change your mindset
We started this blog with the idea of money that’s free. And that’s where we’ll end it, too.
Understanding the financial language of cash flow will help you gather and analyze the right data. It will help you with reporting and maintaining important financial records. But solely relying upon the theoretical won’t necessarily help you make decisions that contribute to positive cash flow. As you saw, most of the cash flow tips we offered involved the place where people and processes intersect. Which happens hundreds, or even thousands, of times a day in the rush of everyday work. That’s why you need a more practical approach.
In addition to asking yourself if a purchase, policy, process or person improves cash flow, ask whether it ties or frees up money. That way you’re thinking about cash flow every day and seeing opportunities to improve it everywhere. That can help you incorporate cash-consciousness into your business’ DNA and take you one step closer to positive cash flow.
For more resources tailor-made to help entrepreneurs launch, run and grow remarkable businesses, step inside The Entrepreneur’s Studio.
Disclaimer: The information provided in this document does not, and is not intended to constitute legal advice; instead, all information, content, and materials available are for general informational purposes only. Information provided may not constitute the most up-to-date legal or other information, and readers of this information should contact their attorney to obtain advice with respect to any particular legal matter, in the relevant jurisdiction. All liability with respect to actions taken or not taken based on the contents here are hereby expressly disclaimed.
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