How to Manage Cash Flow: A Guide for Small Businesses

Cash flow is the lifeline of small businesses.

Studies across markets consistently show that a significant share of small businesses fail within their first few years — and cash flow problems are one of the most commonly cited reasons. As a small business owner, it is crucial to understand cash flow and how to manage it effectively for your business to survive in the long run.

Cash flow is the effective movement of money in and out of the business. It is cash flow that supports payments such as rent, utilities, salary, supplier bills, taxes, investments, and growth plans. For your business to operate smoothly without financial bottlenecks, you need to receive cash on time for the goods and services you offer.

This guide will cover what cash flow management is, the challenges faced by small businesses in cash flow management, and how to address the challenges, and ensure your small business can perform better instead of just surviving in the years come. We will also cover warning signs to identify potential cash flow problems.

What is cash flow management?

Cash flow is the movement of money in and out of a business within a certain period of time. This is different from profits, which is essentially sales minus the expenses based on accrual. Cash flow management is done only when money is paid or received and not when an invoice is raised.

Positive cash flow means there is more money coming into the business than going out, while negative cash flow is the opposite.

It is ideal for small businesses to have visibility into their cash flow to monitor their business health and maintain a positive cash flow. A positive cash flow can help small business owners plan for growth, pay expenses, and build reserve funds for turbulent times.

Cash flow statements built on clean books which hold accurate financial records of all business transactions and bank statements can offer clarity to a small business to drive strategic decision-making.

Cash flow can be split into three categories.

1. Operating cash flow: This involves money from your main business activities such as sales revenue, supplier payments, rent, salary, and utility bills.

2. Financial cash flow: This is money flow between your business and external sources such as funding, dividend payments, and loan payments

3. Investing cash flow: These transactions are less frequent. It is the cash flow around activities such as buying and selling assets like equipment or property.

Why is cash flow management important for small businesses?

Small businesses run on small margins and cash flow management is key to sustainably growing the business. Without good cash flow management, small businesses run into risks. Here are some benefits of proper cash flow management.

Run your business

Setbacks such as a delayed payment from customers can hold you back financially since your business still has to pay rent, salaries, utilities, and refill stock to keep the business running. Good cash flow management can help you plan and set up reserve funds to serve as cushion without impacting operations.

Plan for turbulent times

Uncertain times such has COVID-19 can have a global impact on supply chain. Small businesses with good cash reserves can forecast and plan inventory stocking to shift payment cycles, and find alternatives for sourcing goods without halting operations.

Develop trust with lenders and investors

Small businesses with good cash flow management can foster relationships with lenders and investors since it is a sign of stability. If the business health is good, it gives investors and lenders the confidence that your business is built not only to grow but also to withstand crisis.

Consistent planning

Cash flow is not an end-of-year review. It is important that cash flow is monitored to understand the ebbs and flows of your business health. It is beneficial to do weekly monitoring when you have just started the business and move to monthly monitoring once the business is stable. It helps you identify peak and off-peak payment periods to prepare for them ahead of time.

Practical guidance for cash flow management

Cash flow management has more to it than just maintaining accurate records—that's just the first step when going through the process. Here are the steps involved in cash flow management.

Forecast your cash flow

Clean historical data of your income and expenses is required to build good forecasts. As a small business owner, you can gather around six months' historical data consisting of invoices, bills, and bank statements. You can use this data to identify patterns in payment and visualise periods when the inflows and outflows vary.

When preparing the forecast, ensure it aligns with reality, meaning the time you actually receive the money and not when you raise invoice for a project. For example, you could be receiving payments 45 days after project completion so your forecast should be based on that and not your 30 day payment terms. This is the same for your payment to suppliers, rent, or utility bills. Note down when you actually pay versus when you receive the bill.

Based on the week's income and expense data, calculate the current week closing balance, which will be the opening balance for next week. A weekly forecast can help anticipate surplus or shortages in the upcoming weeks, and predict sales realistically. It is good to be ambitious but reality dictates your cash flow. Don't forget to consider increases in cost of materials or an upcoming seasonal fluctuation in demand.

Monitor cash flow

Tracking actual weekly cash flow and comparing with the forecast will provide small businesses the guardrails it needs to improve cash flow. Consistent monitoring allows small business owners to adjust for future weeks based on the evolving supply chain and business conditions. This is not a one-time process but a continuous one and over time your forecast accuracy will improve.

When your business finances are maintained on an accounting software, like Zoho Books, you have access to historical data and it can be fetched based on the period. You can use the powerful reporting system to obtain cash flow statements and use built-in AI features to forecast and detect anomalies easily.

Expedite inflows

Send invoices as soon as possible. It is advised that you don't wait until the end of the month to invoice your customers. The sooner you invoice them, the faster you get paid.

Establish payment terms

Set payment terms based on the customer type or project timeline. For new customers, request payment on delivery. For existing loyal customers, support them with a discount for early payment. If it's a project that takes a long time, use staggered payments after certain milestones so you don't wait until project completion.

Chase unpaid invoices

It is crucial that you follow up on those unpaid invoices. Set up reminders on a 7-, 14-, 21-day period to remind customers. This could vary based on your payment terms. A reminder before the due date, one on the due date, and one overdue reminder when it is past the due date is ideal. Look to add late penalties if necessary.

Offer multiple payment methods

Offer easy payment methods to expedite and ease the payment process. Support multiple modes of payment such as bank transfers, credit cards, debit cards, or through other digital payment platforms. Easing the payment process is a step towards accelerating payments.

Optimise outflows

Outflows are nothing but the amount your business owes to suppliers and other vendors to keep your business running smoothly. When you make payments, the cash available to your business gets affected and therefore, it is important to plan payments. So, here are some steps to take to optimise your accounts payables.

Find out the due date for your supplier bills. Negotiate to increase the payment terms with your supplier. For example, you can negotiate to move from a payment term of 30 days to 60 days which means you have capital freed up for another month and this gives extra time for you to collect payments from customers.

Leverage early payment discounts offered by suppliers if it is reasonable and adds value. Some discounts are not worth it when you anticipate the need for working capital.

Identify areas where you cannot afford to delay payments, for example, payment of salaries or taxes can rake up late payment fees.

Track expenses

Expense management is crucial for every small business owner. Most businesses pile up expenses without considering their income and it turns out to be a nightmare when you lack the required cash inflow.

Track all your expenses including recurring ones and evaluate them regularly. This will help small business owners understand where they spend their money and re-evaluate if it's really needed and allow for better budgeting. This also gives visibility into subscriptions your business might have signed up for early on but not using them any more.

Look for areas where you can optimise and also look for shifting fixed costs to variable costs. Consider bulk orders, outsourcing, hiring part-time employees for seasonal demand, and buying used office equipment.

Build reserve funds

Small businesses need to allocate money to build cash reserves which can be used when times are difficult. You can regularly set aside a percent of your revenue as reserve. You can instil this habit by categorising it as a non-negotiable and consistently setting aside money.

It is ideal to plan a two- to six-month cash reserve. You can also optimise on the percent of cash reserve for each month based on sales fluctuations. In a peak period, a higher contribution to the reserve fund can compensate for the lower contribution in a low period.

Strategies for effective cash flow management

Here are some of the strategies for small business to grow and weather all challenges that arise.

Adjust pricing

Conduct A/B testing to identify the buying power of your customers based on the units sold for each price. During A/B testing with prices, consider offering products with different profit margins applied. When evaluating results, consider the fluctuation in demand and the increase in costs as well.

For example, if you run a travel company, you could also adjust profit margins based on seasonal fluctuations—increased prices during peak demand and lower profit margins off-season.

Another option would be to revamp pricing based on tiers, subscriptions, or packages, to support cash flow throughout the year.

Manage inventory

Track your inventory based on customer trends and business conditions, and manage it efficiently to align with your cash flow. This helps you plan based on the demand and avoid issues that arise from surplus and stock shortages.

Review monthly

Cash flow management is not a one-time process. Ensure you are reviewing constantly to align actual sales with forecasted cash flow. This helps fine-tune your forecast to be more realistic.

Establish a rolling 12-month budget instead of an annual budget. As a small business owner, this helps you incorporate actual results from the completed month into the extended month for budget planning.

Find financing options

Although your business is operating smoothly, it is recommended you find financing options ahead of time. You can look into options such as overdraft, revolving credits, business lines of credit, bank loans, lenders, and invoice financing to reduce stress when you are faced with a cash flow bottleneck.

Manage growth cash flow

As a small business owner, you're not just running a business; you have a vision for the future of your business. Growing your business means you are taking bigger orders, which means your operating cash flow increases. It is important to scale gradually at rates to be in line with the cash generated. Scaling too fast with longer payment cycles can add financial pressure. Establish finance for growth plans ahead of time and monitor weekly cash flow during this phase is crucial.

Warnings signs your cash flow needs attention

Cash flow troubles creep up when there is lack of visibility and monitoring. Here are some of the signs that your cash flow needs serious attention.

• Your account receivables are piling up without payments.

• You're considering hiring someone to chase invoices.

• Unable to pay suppliers since cash is not available.

• Your business relies heavily on payments from large order customers.

• Under constant stress to pay employees on time or using reserve funds for payroll.

• You're constantly using funds from your cash reserve or seeking loans to support business operations.

Apart from this, if the overall positive cash flow figure is driven by financing and investing cash flows while operating cash flow is negative, your business could be in trouble.

How can Zoho Books help small businesses manage cash flow?

The entire process of cash flow management can seem like a stressful task. A cloud-based accounting software like Zoho Books can support small businesses in running their financial operations and provide accurate data as the foundation for effective cash flow management strategies. This is how it can help:

• Get paid faster by automating invoices and triggering reminders for payments.

• Speed-up bank reconciliation by connecting to a bank.

• Ease your payment journey by integrating with multiple payment options.

• Real-time visibility into cash flow with live dashboards.

• Consistent performance reviews through 70+ reports.

• Track and asses inventory based on demand.

• Scale up with multi-entity and multi-currency support.

• Stay compliant with tax regulations and never miss a deadline with direct filing capabilities.

Zoho Books offers a comprehensive free plan for small businesses to get started and affordable higher tiers as the business grows. With the right accounting software, you can automate all financial operations and gain the visibility into your business you need to have valuable conversations with your accountant to pave way for strategic, informed decisions.