5 common cash flow missteps and how to avoid them
It is easy—many would say inevitable—to run into a cash crunch, even if your business is thriving and profitable. A slowdown in cash coming into a company can catch even seasoned and successful business owners unaware and cause dire results.
In addition to the stress and the inability to meet your financial commitments, a lack of cash can hurt your company’s reputation and its ability to take advantage of important opportunities.
The good news is that cash flow pinches can be easy to predict and avoid, and the effort is well worth it.
Consider these common mistakes and learn how to avert them:
Mistake #1: Not enough forecasting
The very first step toward avoiding cash crunches is to identify them before they strike. A lack of cash flow forecasting fells some businesses, since cash flow and profitability are not equal. You can be in the black and still have a serious cash crunch based on timing differences between when you receive payments and when you pay your bills.
Cash flow forecasts enable you to map out when cash will come into and out of your business to ensure that you always have sufficient funds to operate. Creating and updating these forecasts takes time, but the process alerts you to impending tight spots and enables you to avoid them.
To build an effective forecast, estimate the revenue you expect to bring in on a weekly or monthly basis, using previous sales or your knowledge of upcoming sales to provide detail. Factor in marketing efforts, economic conditions, seasonal sales cycles or other considerations that may impact your figures. Be sure to note when you expect to receive payments, since this is the “flow” part of cash flow.
Add your expenses to this document to round out your cash story. Include fixed expenses such as rent and payroll and variable expenses such as planned purchases. Then, add your revenue minus expenses to your bank balance for the time period you want to forecast. Be sure to revisit and update your forecast based on how your business has actually been performing. This cash flow calculator can help you build and maintain your forecast.
Mistake #2: Invoicing slowly or irregularly
Your financial obligations—rent, payroll, utilities and other expenses—occur regularly, and your invoicing needs to keep pace. In some companies, invoicing takes a back seat to completing work and chasing sales. This habit can lead directly to cash flow issues. Some customers will drag their feet on payment no matter what you do, but proactive invoicing will help to minimize the impact of this. Creating a process for invoicing will ensure that it is folded into the work you do and is never overlooked or delayed.
Good invoicing habits should include billing up front whenever possible. Often you can charge for a portion of a project when the work begins to keep revenue flowing through your company. This is particularly important if your order requires you to spend on resources to complete the work. If you bill only upon completion, be sure to invoice promptly. Even a short delay can mean missing a customer’s payment cycle and holding up payment. Some businesses create invoices at the start of a project and cue them up for quick delivery upon completion.
Mistake #3: Not encouraging quick payment
Along with sending invoices promptly, be sure you are taking other steps to expedite payments. Accept multiple forms of payment, including cash, check, credit or debit card, or automated clearing house transactions, so that customers can pay using the method they prefer. Consider offering a small discount for early payment, such as two percent if settled within 10 days, or charging a late fee or interest for payments that are past due.
Check with new customers to be sure you are including all of the information needed to move your invoices through their systems quickly. For example, is a purchase order number required on all invoices, or will your company invoice number suffice? Do they need an itemized list of work completed or just a general description? Also find out how customers prefer to receive invoices, whether by mail, email or fax.
Mistake #4: Using cash for long-term assets
Buying equipment or other long-term capital improvements outright can constrain your ability to meet unanticipated expenses or other short-term obligations. A more effective way to manage growth is to match financing to the life of the asset. For example, using a loan or lease to finance equipment you will use for years to come will allow you to benefit from the equipment while preserving liquidity. This piece of advice is particularly important as businesses’ inventory and receivables grow with the improving economy. Not having a cash buffer to accommodate this growth could squeeze cash flow.
Mistake #5: Not building a cash reserve
Having a cash cushion is critical for managing unexpected expenses or riding out sales slowdowns. It can also enable you to seize opportunity—for example, a steep price break from a cash-crunched supplier if you are able to pay immediately. While the amount you should have in reserves depends on your industry and seasonality, three to six months of savings is a good rule of thumb.
A line of credit is another important tool for handling unexpected expenses and shoring up short-term cash flow. For example, a business might tap into a credit line if scheduled receivables are late and an operating expense such as rent comes due. Keep in mind that the best time to apply for a credit line is before you need it—in other words, when your cash flow and balance sheet are strong.
Your business banker can be a valuable resource in helping you find other ways to strengthen and protect your cash flow. Learn about the treasury management tools California Bank & Trust offers to help you convert receivables into cash more quickly and manage payables more effectively.