Cash flow is the foundation of business success, and regardless of whether times are lean or not, it’s important for all entrepreneurs to understand what it takes to have enough working capital on hand to keep going. Whether you’ve been an entrepreneur for years or you’re just starting out, revisit the basics of managing cash flow.
All companies should start with a goal of how much working capital (we define as current assets over current liabilities) is needed to effectively manage the ebb and flow of the work and the cash flow fall-out which happens after the work is done. The working capital needs change from company to company, industry to industry. If your business model is to not only pre-bill but also receive payment prior to starting work then your working capital needs differ from a business performing services first and then billing for services rendered.
As a general rule, we try to have our clients maintain a minimum 5% working capital ratio (of annual revenue) if they are in the services industry, and a minimum of 10% working capital ratio (of annual revenue) if they are in the construction, manufacturing, or heavy industry where a large portion of the Cost of Goods Sold is in labor performed.
The first step to really reigning in your cash flow is determining how much money you need to live on monthly and how much your business needs to survive. Once you’ve established these numbers, you can create a baseline. Don’t forget to include emergency savings along with monthly expenses to create a nest egg for anything unexpected. If you’re just starting your business and have no concrete idea of numbers, underestimate your income and overestimate your costs — it’s better to have an excess in your budget than to run out and find yourself in a cash crunch.
Businesses usually have consistent income and expenses, including bills, inventory costs, and regular customers. After establishing your monthly financials, track your regular accounting numbers, and make adjustments as needed. Use accounting software that provides a visualization of this data and get reports that highlight areas for better cash flow management. Anticipating cash flow will also help with any necessary adjustments before things get out of hand and you find that your business is a little short on cash. You’ll also be able to see where you can cut back on the money coming in and out.
When you do have some extra funding in your budget it can be tempting to immediately update your office, invest in expensive tech, or go on a hiring spree. If you’re putting time and resources into building a top-quality product or service, these expenditures shouldn’t matter. Bootstrap first before hiring, keep your workspace basic, and use the tech you have on hand for as long as possible before having to upgrade. Don’t borrow more money than you need if financing is required for growth and ensure that you have room in the budget for another monthly payment and the interest that comes along with it.
While staying lean is one way to help keep cash on hand, so too are the extra steps of taking cost-cutting measures where you can. Speak to your vendors and strategic partners about discounts for early invoice payments, price matching, or referral bonuses — even a few dollars can save over the long-term. Other ways to save include leasing equipment instead of buying it, getting business credit cards with cashback or rebate rewards, paying off card balances on time to avoid interest, and consolidating business debt for lower interest or monthly payments.
Getting paid on time means your business cash keeps flowing, so optimizing your invoicing process goes a long way towards managing cash flow. First and foremost, make sure you’re sending out invoices regularly and on time, and check that all of the information is accurate. Even something as small as an incorrect address can delay your payment. Include language that addresses invoice payment expectations in any contracts you sign with clients. Build a reputation as a business that is proactive about collecting and fulfilling invoice obligations.
The only way to know how to best manage your cash is by looking at the books, and if those aren’t accurate, you’re headed for trouble. Beyond integrating a sound system within your business, you can also use tech tools or even outsource this business so you have peace of mind that your numbers are correct and updated in real-time. Having an at-a-glance, bottom-line look at your business’ financial health will also let you easily make important purchase or investment decisions based on what your cash flow situation looks like at any given time.
It’s not unusual for entrepreneurs to find cash flow management challenging. In fact, it’s a common reason why many businesses struggle to survive. Small business owners sometimes need to leave their comfort zones to find success, and this can include seeking out professional coaching. If you’re looking for cash flow management guidance as you work toward growth, you’ve already taken an important first step. No one can improve if they aren’t willing to learn, and a part of that comes from acknowledging that you aren’t perfect. You’ve made mistakes, but a dependable small business coach can help you avoid repeating them — let’s talk.