Why Cash Flow is so Important For Small Businesses

Written by
Eric Quick — Co-Founder & CEO, PocketCFO

A healthy cash flow is critical to keep any small business running smoothly. If you aren’t focusing on managing yours now, then you could be setting your business up for failure.

But managing cash flow can be especially challenging for founders. That’s why we’ve put this guide together for small businesses. 

In this post, we’ll discuss what cash flow statements and forecasts are, along with actionable tips to help business founders better manage their cash flow.

What is a cash flow statement?

Cash flow statements track the cash coming in and going out of your business over a specific period of time. It’s one of the most important reports for the financial health of your business.

A cash flow statement includes details about the company’s cash outflow and inflow. Having cash on hand is crucial if a business wants to avoid bankruptcy, a real concern, particularly in the first few years of operation.

A cash flow statement will break activities into the following three categories:

  • Cash inflow: All of the cash that’s flowing into the business at a given time, like from new sales transactions. 
  • Cash outflow: Operating costs like accounts payable, payroll, office expenses, income taxes, etc. 
  • Investing activities: Purchases or sales of long-term investments like vehicles, machinery, equipment, or property.

What is a cash flow forecast and why is it important?

A cash flow forecast is a statement that includes future expectations of profit or loss. Cash flow forecasting is critical for helping businesses estimate cash movements in the future. With an accurate cash flow forecast, you can help prepare for unforeseen expenses and make better use of your cash on hand.                                                                                                                                                                 

8 tips for cash flow management for business founders

Cash flow management is a critical piece of finance to get right so you can set your new business up for success. Here are 8 of our top tips to help founders manage their cash flow:

1. Make only essential purchases

In the early stages of business, it doesn’t make sense to make elaborate and unnecessary purchases. You’ll want to focus on just the essentials so you aren’t tying up cash that could be used to pay bills or expenses.

When making a new purchase, ask yourself first if it’s absolutely necessary. For example, shipping boxes and packing materials are necessary to run your business, but new office decor is not. Save those purchases for later down the road when you’re bringing in a more consistent profit.

2. Understand your break-even point

Knowing when you will break even won’t directly affect your cash flow, but it can give you an automatic goal or target to shoot for with your forecasting. Understanding this number will help you budget accordingly.

For example, let’s say your set monthly expenses are at $900. You’ll know you need to pull in $900 to break even. If profits are low for the month, you would know to be cautious about taking on additional expenses until after the $900 target was met.

3. Collect payments early

The sooner customers pay their bills, the more funds you’ll have on hand. To get cash coming in sooner, you’ll need to offer an incentive. Try offering terms for customer payments. You can also use a discount to entice customers to pay their invoices sooner.

For example, you could offer a 10% discount for anyone that upgrades to an annual plan instead of paying monthly. Customers might be paying less initially, but they’ll be freeing up funds for your cash flow.

4. Outsource tasks

Not every task should be executed by the founder. Many founders will try to take on every task possible in an attempt to save money. However, this has the potential to hurt your business more in the long run. As a founder, you’re pulled in many directions. Make sure you’re using your time wisely.

For instance, as the founder, say you’re the one producing financial reports like your cash flow statement. Without specializing in accounting or financing, you’ll likely spend more time on generating the statements or reports than a financial expert that could complete the work in a  fraction of the time.

5. Hire strategically

As a new business founder, you’ll likely get advice telling you not to hire anyone until you have to. While this can help with your cash flow initially, you may also be hurting your business if you don’t implement smart hiring.

For instance, hiring one highly skilled employee that can take on the workload of two average employees can be a smart investment. You’ll spend less on turnover and correcting mistakes. Take the time to look for smart talent early on, so you won’t be desperately trying to fill the role when business takes off, and you need to find help ASAP.

6. Use accounting software

There’s an abundance of business software available to help small businesses streamline their operations. One such software option that ties directly to cash flow is cloud accounting software, like Quickbooks or Xero. Utilizing accounting software can help you quickly and accurately prepare financial reports. It also keeps your financial data safe and secure within the platform.

Not to mention, if you pair your accounting software like Quickbooks with PocketCFO, you can automate cash flow management.  

Without the software, you would rely on the time-consuming and tedious task of preparing statements and projections yourself via spreadsheets. Which, as mentioned above, can demand more of your time than you realize if you aren’t a financial expert.

7. Build a cash reserve

You should always have a rainy day fund set aside for months where you have higher expenses or a shortage of cash. Every early stage business seems to struggle with a shortfall month or period in the beginning, but it doesn’t have to leave you stressed.

How much should you save? Aim for three to six months of expenses. This isn’t always realistic as it takes some time to accumulate, and some businesses are particularly strapped for cash in the beginning, but this number can help get you through the tough times so you can focus on running your business.

8. Don’t mix business and personal

You should know this already, but the importance of this tip cannot be overstated. You should never mix your business and personal expenses. Some entrepreneurs blend this in the beginning, making a business purchase here and there on a personal card.

Why is this a problem? Using your personal accounts for business makes it difficult to track your business transactions. It can hurt the accuracy of your cash flow projections, as well as make it a nightmare when it comes time to tax preparation. 

***

The most important piece of advice to keep in mind while going over these tips is that you need to implement them quickly. The sooner you start focusing on your cash flow and setting up systems to track it, the better.

Congratulations, you are one step closer to becoming a financial whiz.

Learn how you can save 200 hours per year by automating your cash flow

11 Ways To Improve Your Cash Flow Immediately

Get actionable tips on how you can instantly improve your financial hygiene

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

Let Us Know What You Thought about this Post.

Put your Comment Below.

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.