When Zoho had a conversation with Ray Trevisan, founder of Sydney-based financial investment firm OTG Capital, about how he runs his business, he said: "When you're starting a business, cash flow is absolutely crucial."
If you ask us, that's great advice.
Why? A key part of building a small business is knowing how to safeguard your business from potential pitfalls. Given that poor cash flow management was one of the primary reasons many Australian businesses failed in the past, it's important to take all necessary precautions to avoid a similar outcome for your business.
What is cash flow?
Cash flow refers to money that moves in and out of your business. Managing your cash flow is all about making wise choices on your spending, and figuring out ways to efficiently keep your cash moving, so you don’t run out of it at any point.
For your business to run smoothly, it needs to maintain a positive cash flow, where the money that comes into your business in the form of sales must be greater than the amount leaving your business. Negative cash flow is vice versa. When the amount you spend on salaries, rent, and other costs is more than your incoming cash, you eventually run out of capital to manage your day-to-day expenses.
Businesses commonly experience negative cash flow when they:
Stock up excess inventory anticipating higher demand.
Price their products with poor profit margins in order to stay competitive.
Invest too early in resources and fixed assets before seeing enough sales.
Underestimate their future expenses.
To avoid making similar mistakes, here are a few tips to stay on top of your cash flow game.
Keep your books up to date
Good cash flow management starts with keeping accurate financial records. The more attuned you are to your numbers, the better your chances are of spotting early warning signs and acting before it's too late. However, as your business starts to grow, the number of customers and vendors you interact with grows as well, and it's easy to lose track of every transaction that happens on behalf of your business. If your business reaches that point, using an online accounting software is the best option. When you have all your financial information in one place, you can regularly monitor the money that moves in and out of your accounts and adjust your financial strategies as needed.
You can read more about how accounting software can help your business in our previous post.
Manage your seasonal demand
Every business has a time of the year when they are the most or least profitable, and it is often during this time that many will struggle managing their cash flow. For example, if you own a beachwear store in Bondi, you typically have more sales from December to March than the rest of the year. However, this also means you have to pool cash for off-seasons (when sales aren't so great) to stock up sufficient goods required for the summer--when your sales will be at their peak. In order to tackle such tricky situations, you must try to:
Get insights on past demand trends so as to time your expenses accordingly.
Maintain just enough inventory to meet demand without tying up too much cash.
Keep in touch with vendors who can supply goods on short notice.
Deal with payments wisely
It doesn't matter how many new customers you acquire, you are going to end up with poor cash flow if you don't receive payments on time. This problem is common in businesses with a subscription or made-to-order model when clients fail to pay their invoices by the due date. One possible reason is that your payment process is complex and inconvenient. Although it's impossible to offer every payment option, you can make it easy for your customers by offering online shopping facilities, multiple payment options, and integrated electronic invoices. If your customers continue to delay their payments even after repeated reminders, it's time to step up and establish clear conditions including penalties for late payments and discounts for those who pay early.
Maintain a cash reserve
Cash reserves are emergency funds that can save your business when it faces an unforeseen crisis. It doesn't matter how well planned you are, there is always the possibility of things going wrong and stalling your cash flow. For this reason, it's always good practice to regularly set some money aside, at least until you have enough cash to cover your expenses for three to six months. This gives enough room for your business to bounce back without having to shut down entire operations.
We hope this post gives you some clarity about cash flow and what you can do to keep your business steady and running. Have any other tips you'd like us to add? Let us know in the comments!