When you own a small business, your cash flow and how you maintain it is incredibly important. Running into a cash flow crisis can lead you to have to make serious budgetary cuts or sell assets. For example, you might have to sell a company vehicle quickly to try and maintain positive cash flow or fire employees.

Below we go into some of the things any business owner should understand about cash flow, how to avoid a crisis, and what to do if you do run into a difficult situation.

What is Cash Flow?

Cash flow refers to the net amount of cash and the equivalents to cash transferred in and out of your company. Cash received are your inflows. What you’re spending are your outflows.

By monitoring your cash flow, you get an idea of what’s coming in versus what’s going out and whether you have a deficit.

If you have more than the necessary money in your business account to cover all your bills and expenses, then your cash flow is positive. If your expenses are more than what’s coming in, you have an issue.

Two terms to familiarize yourself with here are accounts payable and accounts receivable.

Accounts payable is a liability account that tracks what’s leaving your business—a.k.a. this is the money you owe. Accounts payable might include payroll, loans, and other business expenses.

Accounts receivable is an asset account where you track money coming to you, for example, from your customers.

A third term that’s relevant is your profitability. Your profitability is determined by adding up all of your assets and then subtracting your accounts payable. If you come up with a positive number, you have a profitable business. If the number is negative, you aren’t profitable. However, you should note positive cash flow doesn’t always mean you’re profitable.

You can also be profitable and not have any cash on hand.

The Importance of Cash Flow

One of the most critical parts of keeping your small business up and running is cash flow. Research shows the most common reasons businesses fail is often because they don’t have sufficient cash on hand.

Along with having positive cash flow, having the right balance of cash on hand is also essential.

If you’re a startup, or you’re thinking of launching one, you’re probably going to need access to cash in your early days as you’re getting set up. You might need to pay a website developer or a deposit on an office space rental, for example. Because of these factors, early on, it’s not uncommon to see money go out of your business faster than it’s coming in.

As your business matures, that should stop.

Understanding a Cash Flow Statement

One of the most important things you can do to avoid a cash flow crisis is understand the technicalities of cash flow itself.

A cash flow statement shows you how your cash is moving in and out. A cash flow statement will usually allocate your activity into three segments. There are operating, investing, and financing flows.

Operating flow is any spending or income coming from your net income. Operating flow could include buying merchandise and revenue from selling products or services. Operating flow transactions are a natural result of running your business.

Investing flow refers to your investments like buying a piece of equipment that you can use in the future to improve your processes, profitability, or efficiency.

The financing flow might include taking out a business loan or anything centering around debt-equity and dividends.

Your cash flow statement is different than your income statement. Your income statement shows your financial performance during an accounting period. A balance sheet takes account of your liabilities and assets as a snapshot over a period of time. Your balance sheet can help show you the financial health of your business at any moment.

The Primary Reasons for Cash Flow Problems

Rather than trying to scramble and come up with cash quickly by doing things you’d rather not, like selling assets, it’s good to be proactive. When you’re a business owner, try to understand the common pitfalls of cash flow management so you can take steps to avoid them and identify red flags that could be happening in your business.

Some of the most frequent reasons for cash flow issues include:

• You spend too much at the beginning. We did talk about the fact that in the early days of your business, you’re probably going to have to invest it in, and you may have to use your own money too. Even so, you still have to be strategic. If you spend too much on your startup costs, you can put yourself at a disadvantage that’s hard to dig your way out of in terms of cash flow. There are things that if possible you should put off buying until you’re more stable in your business.
• Not keeping track of expenses is so easy to overcome, yet so frequently leads to cash flow disasters. As soon as you start your business, you should have an accounting system in place to track income and expenses. Your accounting system can be as simple as a spreadsheet, as long as it lets you see your expenses.
• When you’re a business owner, you want happy customers. That can make it challenging for you to be firm when it comes to paying invoices, but when you let customers delay their payments, it can end your business.
• If your business has seasonal elements relevant to the operation, you always need to be planning ahead for this. Even highly successful companies tend to experience low cash flow depending on seasonality. Don’t put too much of your personal money into these slow periods either—think about working capital solutions instead.
• Inventory management is complex right now. Businesses slowed their orders during COVID-19, and now, as they’re trying to ramp back up, they’re being hit with backlogs and supply chain disruptions. Even so, be as strategic as you can with your inventory management. If you have too much inventory, you won’t be able to sell it fast enough to cover expenses related to buying and storing it. At the same time, if you don’t have enough inventory, you won’t meet customer needs, and they’ll go elsewhere.

What Happens If You Hit a Crisis?

Even with careful planning and an awareness of your cash flow, you can still come to a crisis point for various reasons.

If you do face a crisis, some of the options you can use to raise cash quickly include:

• Business cash advances: Merchant account companies and some digital payment solution providers will offer advances against your future card sales receipts. While it was once known as being very expensive and often not worth it, terms tend to be more favorable now. You may hear this referred to as a working capital loan or maybe a line of credit. You get an advance, and then you repay it from your future sales. You do have to pay a fee for the advance.
• Make adjustments to your business plan: If you encounter a cash flow shortage, you may need to look at your business plan and operations, processes and expenses. Why is it happening, and what can you do to avoid having it happen again? You might, for example, realize you need to cut some things and then focus on the most profitable services. You might end up letting go of clients who are more expensive than their worth, or you could spot areas of waste.
• Speed up receivables: When you’re dealing with cash flow problems, you need to get money flowing into your business. You can ask customers for partial payments or deposits upfront as a way of bringing in cash rather than invoicing them for the entire total after the product or service is delivered. You can send invoices early and more frequently and put your focus on past due accounts. You should also make it as simple and easy as possible for clients to pay.
• Negotiate payables. Along with bringing in more cash, if you think you have an impending crisis on the horizon, you can try to reduce what’s going out at the same time. Talk to your vendors about what’s going and see if you can delay payments or negotiate terms. There will be vendors who are willing to work with you, although they won’t all be.
• Cut your expenses: Every penny that is leaving your business and your accounts needs to be something you’re very aware of. You need to be especially mindful during a cash flow problem.

Finally, we talked about this above, but you may end up selling non-essential assets. For example, maybe you have a business vehicle that you don’t need or a piece of equipment you aren’t using it. It’s a quick fix, but sometimes it’s the best financial choice you have available to get cash fast.

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