Why managing cash flows is so important for small businesses

Cash crunches are one of the key issues that face small businesses on a daily basis, which creditors to pay when, and managing it correctly can be the difference between survival and going to the wall.

As the old adage goes ‘turnover is vanity, profit is sanity and cash flow is reality’. So, what is cash flow? Put simply, the term covers the money a company has available for use at any one time. It is not turnover, and it certainly isn’t profit, which, though integral to any business, does not accurately reflect how well it is managing its finances.

Why is cash flow important?

Good cash flow management is particularly crucial for small businesses – to maintain stability and to help move forward sustainable growth plans. In fact, cash flow is one of the top concerns among small business owners. According to an independent Barclays study compiled in 2017, almost two-thirds of SME (small to medium enterprise) leaders listed cash flow as their biggest concern. And as the number one cause of entrepreneurial failure is businesses running out of cash, those worries are well-founded. While there is no magic service to resolve cash flow complications, there are numerous measures you can take to keep a close eye on your cash. From disruptor-led banking services to simple management methods, here are just a few of the ways for small businesses to keep an eye on things.

Maintaining a positive cash flow

In an ideal world, a business’s day-to-day income from sales or transactions should offset your expenditure, with a little left-over. Unfortunately, there are many possible complications that can throw this basic equation out of kilter. The most common offender is delayed or defaulted payments, which have the potential to de-rail otherwise positive cash flow. The Barclays study also suggested that 25 percent of SME leaders were most concerned with guaranteeing the date of payment from customers and clients – no surprise there.

Yet, imprecise date of payment is a fact of business, and like all facts, it should be accounted for. To prevent negative cash flow, do not count your chickens – the financial promise from a disclosed deal or won client should not be treated as cash-on-hand, and spent before it arrives in your bank account. 

Likewise, try to maintain a balance between inventory and sales. The procurement of inventory is non-reversible, and you could well incur a sunk cost until profits from sale make up the difference. Be careful about the lure of a discount for bulk orders, they might be cheaper, but if there is not a corresponding increase in the rate of sales, your cash flow will take a substantial, potentially calamitous hit, which could well stifle future growth.

As many small-business-owners will know only too well, the rate of cash flow is not constant throughout the year, fluctuating between so-called on- and off-seasons.

All manner of variables affect the seasonality of a business’s turnover, but it is vital for small businesses to forecast these factors in and to adjust their expenditure accordingly to maintain positive cash flow. For example, lump sum purchases should be made when the rate of sales will allow for that cash to be recovered quickly. Similarly, if your business fluctuates between negative and positive cash flow throughout the year, plan ahead and conserve a surplus to help you shoulder the off-season.

Retaining cash flow during critical growth periods

Every business goes through critical stages of development (CSDs), which for small businesses can range from something as seemingly small as hiring a new employee or taking out a new marketing contract. And these moments need to be anticipated, as very few small businesses will have the necessary capital to consistently offset the costs of growth. More often than not, money must be borrowed – but a standard loan is not the only option. Increasingly, small business owners are turning to working capital loans and credit lines. 

So how are these different? A working capital loan differs from a traditional loan in that it is not used to buy certain assets that will then be offered as collateral; it is cash on hand designated for the specific spending of day to day operations. It can be used to cover general expenditures while a company grows into its new clothes, so to speak. More advantageous still: a working loan need not be administered by a bank. Transactional services, such as PayPal, offer working capital to customers with a history of sales. PayPal specifically offers loans of up to 35 percent of annual sales on a percentage-of-sale repayment scheme.

It’s worth bearing in mind that credit lines can give you flexibility, and can be a welcome anchor when dealing with fluctuating sales. A line will guarantee a maximum amount, for example £30,000, to be withdrawn by a business. However, the interest will only be applied to the amount withdrawn: if only £10,000 of the £30,000 is withdrawn, then interest is applied solely to that £10,000. 

Keeping tabs

Managing cash flow is, above all else, a question of record-keeping and planning. Most SME leaders report at least half their working day is spent calculating cash flow. That situation is fast changing however, with the emergence of disruptors – and it may well be worth fledgling businesses signing up for accounting software services to better track spending. Software vendors Xero and FreeAgent, cater for small business owners in particular. Interestingly, disruptor banks, most prominent among them Tide and Starling, are beginning to integrate their business accounts with these vendors. The result is a streamlined, simple process for money management that can dramatically reduce the chances of getting into a sticky spot. And, if ever a pitfall should arise, there’s always the business overdraft.

Positive cash flow is a key building block of any successful small business, and with caution, foresight and planning (and possibly a bit of help from some helpful software) you can easily keep on top of it.

Frances McMonagle
Originally from “Up North“, since moving to London a few years back Fran has made it her mission to make the most out of living in the city. She can usually be found with a green tea, coffee or cocktail in hand busy taking far too many photos.

Date published: 15 October 2019

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