This article originally appeared on NerdWallet and is shared with with permission.
Businesses face many hurdles, especially when just getting started, and cash flow is near the top of the list. Even for profitable companies, it can be a challenge to make sure that more money is coming in every month than is going out. Inventory, accounts receivable, vendor contracts and payroll all must be managed effectively so companies don’t lose out on needed investment and growth due to a shortage of working capital.
We asked Jeremy Office, a Delray Beach, Florida-based wealth advisor to entrepreneurs and a member of NerdWallet’s Ask an Advisor network, about ways business owners can control their cash flow and grow their businesses.
Why is managing cash flow important for small businesses?
Managing cash flow is the determining factor of whether a business succeeds. Statistics show upward of 50% of businesses fail. In many cases, these are profitable businesses, but they close their doors due to poor cash flow management. While the primary concerns are obvious, such as meeting payroll or paying a supplier, it’s the ripple and compounding effects of consistently poor cash flow management that can be truly damaging.
Here’s an all-too-common scenario: Bob’s Dry Cleaning is a profitable business, so Bob decides to make a down payment on a new piece of equipment. He doesn’t pay attention to cash flow, however, and the money he spent on the equipment was needed for payroll that week. He doesn’t have the cash and fails to meet payroll (this wasn’t the first time), so his pickup/delivery driver quits. Bob is in a panic and shifts his focus to pickup/delivery to fill the void while also trying to find a new driver. Bob doesn’t have time to call other accounts to collect receivables in a timely fashion, so a couple more payments are delayed.
Meanwhile, Bob’s biggest client is unhappy because his deliveries are delayed, and he decides to find a different vendor. The next payroll cycle arrives, and it’s twice as big now. At the same time, rent is also due, and Bob has a new payment owed on the equipment purchase he made. Bob can’t go two cycles without paying his employees, so now Bob’s time is spent managing late payments to his landlord and equipment vendor and assuring them he’ll pay ASAP.
Bob is frantically trying to understand who owes him money and calling them to get paid. He has no time to focus on getting new accounts, so his sales start dropping. Bob starts losing clients because the delivery driver he hired out of desperation hasn’t had the proper training and mixes everyone’s clothes up. Before Bob knows it, he is consumed by his business and doesn’t know what to focus on. His once-profitable business is now on the verge of closing its doors because he no longer has the revenue to support his monthly burn.
A small business that needs to implement a new strategy — for example, increasing inventory for the holidays, hiring new employees, implementing new technology or buying new equipment — can do so faster and have conviction in its decision if it understands the repercussions and plans for the cash flow impact. Cash crunches are inevitable for a small business, but it is much easier to overcome when the business anticipates and has ample time to find a resolution.
What should small-business owners keep in mind to most accurately calculate cash flow?
They should stay focused on actual rather than hypothetical data. Small-business owners often make decisions based on the expectation of receiving cash in the future, and when that doesn’t happen, it can put them in a cash crunch. This isn’t to say you shouldn’t account for future receipts (as this is important in modeling cash flow), but rather you should be realistic as to when such receipts will be received. If an invoice owed to you is due in 30 days but the customer has always paid 15 days late, you should account for the additional delay when projecting cash flow.
It’s important that small-business owners continually monitor their cash flow process to ensure their expectations are in line with what actually happens. This will help build conviction and reliance upon the process.
What are some simple tools small businesses can use to track their cash flow?
Tools for managing cash flow are abundant and vary based on the information needed, technical expertise required and level of automation. Various websites dedicated to small business, along with well-known business applications such as Microsoft Office and Google Docs, have created standardized templates that can be downloaded for free. In recent years, there have been various software platforms and applications that have surfaced to help manage cash flow. A simple Google search will yield a multitude of platforms, including Pulse, Float and Up Your Cash Flow. And many of the leading accounting programs have started incorporating cash flow management tools (for example, QuickBooks’ cash flow forecast report).
Each option has its own strengths and weaknesses, and a small business should base its decision on the tool that it finds most efficient. A tool is only beneficial if the information it provides leads to actionable results, so if a small business finds that a tool is too complex or it is not able to pull beneficial information, the owner should look for another solution.
In general, it’s a good idea to hire an independent consultant to establish the framework and teach the business owner how to utilize cash flow. This provides a resource to call with questions and leads to a deeper understanding.
The article Why Ignoring Cash Flow Can Kill Your Small Business originally appeared on NerdWallet.