Perhaps you’ve seen a trendy café in your neighborhood suddenly shut down. Or maybe you’ve seen a local nail salon go from one bustling location to a six-shop regional chain to bankruptcy in under a year.
Much less visibly, thousands of trucking companies, landscapers, plumbers, and graphic designers hang out their shingles every year. Then, after a little while – even if they’re growing and making profits – they close up shop.
These business failures usually stem from cash-flow problems. That’s because revenue growth and hefty profits do not equal cash. Without cash, a business can’t pay its creditors, its landlord, or its employees. And no business will stay open long if it can’t do those things.
Cash is the lifeblood of any business – making successful cash-flow management among the most crucial parts of running yours. You track accounts receivable, accounts payable, and your business’s other key numbers. And you work constantly to cut expenses and increase sales – and to get your hands on the cash those sales promise.
According to a 2013 University of Tennessee study, 25 percent of new businesses fail after one year, 36 percent fail after two years, and 44 percent fail after three years in business. And Dun & Bradstreet Small Business finds that 90 percent of small-business failures are due to shoddy cash-flow management
Now, grasping cash flow’s importance is relatively easy. Maintaining positive cash flow is much more difficult, even for profitable businesses. These five tips will help business owners of all sorts do the work necessary to achieve that.
1. Be Conservative
Start out by creating a realistic budget, calculating when you expect to break even and working toward that. Include everything – operating expenses, salaries, taxes, equipment maintenance and raw supplies – in any budget.
Further, be conservative in your spending. Consider the benefit every time you reach for your checkbook or credit card. When equipment breaks down, repair it. And if you have to replace, consider buying used equipment. One more “conservative” tip: Set aside the funds you’ll have to pay taxes with as you incur those taxes rather than digging up cash when they’re due.
2. Get Paid
It’s crucial to make collecting receivables a top priority for your business, which is why you need to ensure you have the right people in place to get the job done.
Start by hiring an experienced controller or CFO to ensure finances are being properly managed. (Your CFO or controller is more than a collection agent and bookkeeper, of course; he or she should also have experience in forecasting growth and in developing place strategies to support that growth.)
Next, set clear policies for “collection days” – how long you’ll wait to get paid – including penalties for late payments, such as 5 percent after five days late. You can also provide incentives and discounts for early and cash payments. If you’re a contractor, invoice your clients early and often – don’t wait until a project is over before sending your invoice. Set up a payment schedule before starting work.
And then follow up on those policies. Stop work after 30 days if you haven’t been paid. Call as soon as a payment is late – and then every week after that. First-time entrepreneurs may think they can depend on collection agencies for this work, but they should be a true last resort. They take 30 percent or more and usually end up collecting just pennies on the dollar.
3. Pay Your Bills
Late fees add up quickly – and, worse, lead to bad reputations. So, watch your “payment days” as closely as you watch your “collection days,” and err on the side of caution when it comes to paying vendors on time. Don’t abuse generous deadlines – get a good reputation and keep your balance sheet clean at the same time.
Don’t be afraid to ask for discounts for early and/or cash payments. Moreover, feel free to “barter” for equipment, contractors, raw materials, etc. Most businesses are happy to haggle in order to land a steady customer who pays on time.
4. Keep the Shelves Bare
It may seem counterintuitive, but if you’re selling a product, keep on hand the least amount of inventory as you can get away with. After all, every dollar you’ve spent on inventory is a dollar you don’t have in cash. And without cash, you can’t do anything. So watch your "inventory turnover" – how long your inventory sits before becoming a sale – like a hawk. And always work on reducing that number.
To keep an eye on these cash-flow metrics, there are numerous cash-flow calculators available online, including one from 1st Mariner Bank.
5. Have a Backup Plan
It’s important for businesses to retain earnings and build net worth to weather difficult times.
In fact, new businesses should always have enough cash on hand to cover two months of expenses. Larger businesses should ratchet that up to three to six months’ worth of reserves. Keep your cash reserves in an interest-paying account, not long-term hard-to-access CDs or stocks or other riskier investments.
All businesses should consider keeping an open line of credit. And many businesses end up having to take out a loan to get through a cash crisis. So make sure your bankers know you – and keep them informed about events that impact cash flow, such as a growth spurt or a major customer behind on payments. If you regularly demonstrate a clean operation, they’ll be much more likely to make that loan when you really need it.
Cash flow management can be daunting at first – and remain challenging throughout the life of your business. But if you keep a realistic budget, manage your expenses and payments due, maintain a healthy “rainy-day fund,” and keep your expenses down, you’ll be doing better than most of your competitors. And you’ll soon be overachieving when it comes to revenue growth and profit.
You may find yourself in need of help along the way. Before calling in expensive consultants, consider contacting the Small Business Administration.