As a small business owner, the primary decision-making rests with you concerning all operational aspects including finances, human resources, sales, product development, etc. While all areas are critical to the health of your business, if you aren’t able to manage your company’s cash flow, it won’t be long before you find yourself stressed out and potentially facing closure.
When you have poor cash flow, it only takes one disaster to leave your company in dire straights. If you want to avoid such a situation, it is best to learn the ins and outs of cash flow management.
The need for cash
All businesses require cash to stay in operation, but startup ventures have the greatest need for a strong cash reserve during the first few years. The first year of cash management is critical, determining the viability of survival in the second year of operations based on year-end results.
Your business relies on cash to meet payroll, take care of tax requirements, buy new inventory, satisfy vendor invoices, and pay property or office rent. While a line of credit can support your company’s expenses, once this line or any other credit options are maxed out, you can be left with a need for cash-based operations. If you don’t obtain financial resources to meet your obligations, you will be forced to close your doors.
By performing a cash flow analysis, you can get a bird’s eye view of your cash position and whether you’re operating cash flow positive or negative. You will need three elements to get started:
- accounts receivables (i.e., what everyone owes you),
- accounts payable (i.e., what you owe others),
- and shortfalls (i.e., items where you owe that exceed the liability).
The goal is to review the money you are sending out and the money you are taking in. You can’t consider the money customers owe but haven’t paid. This is considered bad debt, and it doesn’t factor into your cash on hand. All of this information can help you determine several key areas of your cash flow and if it is moving in the right direction.
1. Your breakeven point
When you’re managing a startup, you need to know the point in time when your business will become profitable. This doesn’t imply a calendar day, but the point in which your income is equal to profit. This is the goal to strive for when you make cash flow projections and devise strategies concerning how to get there. You can use a unit-based or dollars-based breakeven analysis that relies on your fixed costs.
2. Cash, not profit
As you work towards becoming profitable, you will use your breakeven point as a benchmark for other decisions. You can still make a profit and be cash-flow negative. Always keep an eye on when customers submit payment. The books may show a record amount in sales, but if customers haven’t paid the bills, you don’t actually have that money.
Consider how quickly you pay your own bills and if it conflicts with when your customers tend to send in their payments. A gap between expense and income can create a precarious cash flow situation. Look for ways to keep unnecessary expenses down if you need to adjust your cash flow more significantly.
3. Create reserves
Just as wise individuals do, stashing cash for a rainy day or emergency is important if you want to retain positive cash flow. The goal should be to have enough cash on hand to take care of six months’ worth of operations. At the very least, you should have three months’ worth of cash saved up.
As a new business, there is any number of things that could require a quick influx of capital. You may have a large order that appears out of nowhere, requiring more inventory, additional equipment, or labor. You could have a piece of machinery break down or experience another dilemma that requires cash to resolve.
If you don’t have enough to take care of the problem, as a small business entrepreneur, you could consider meeting with successful investors like Mark Stevens and pitch your business to be the recipient of venture capital. There are also traditional and untraditional lending options from financial institutions that can give you quick access to some cash. Having cash on hand can help keep your company from going under if there is a change in the market or if a tragedy strikes your company.
Keeping cash flow on track
To keep your cash flow management on the right track, invest in an accounting software tool for your company. You will be pulled in many directions as you manage your business, and finances shouldn’t be left on the backburner or until the last minute. Outsource your accounting and bookkeeping needs or rely on a user-friendly money management tool to stay on top of your cash flow position and income compared to expenses.
Megan Wright is the Chief Editor for ChamberofCommerce.com. Chamber specializes in helping small businesses grow their business on the web while facilitating the connectivity between local businesses and more than 7,000 Chambers of Commerce worldwide.
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