You’ve heard the figure that 50% of new businesses fail within the first five years, but most of the time it’s not because they had a bad product or the owner wasn’t capable, the biggest killer of new startups is actually cash flow.
When you think of the important financial figures to keep track of within your business, the first ones to spring to mind will probably be profit, expenses, sales etc. But while these are all vital numbers to know – there is one thing to keep track of that is absolutely crucial to the success of your business – your cash flow. You may have a solid plan to be raking in profits by month eight, but if you don’t manage your cash flow effectively, you won’t be operating long enough to get there.
This article will look at exactly what cash flow is and how you can track it, manage it and improve it to keep your business fluid.
What is Cash Flow?
While revenue and expenses track what comes in and goes out of your business overall, cash flow is about what is going in and out of your business right now. It’s about having the fluidity in your assets to be able to operate. For example, let’s say you have expenses this month of £400. And you have just closed a sale that will bring in £1000 next month. On paper, that equals a profit of £600, but in reality, it leaves you short of £400 this month and you will be unable to pay your expenses, unable to operate, and unable to get to the point where that sale comes in. So cash flow is about focussing on more than just what’s coming in and out, but looking at when it’s coming in and out and making sure you have the fluidity to cover your outgoings.
It’s All About Planning
The most important part of keeping on top of your cash flow is thinking ahead. While you can never predict the future, having an idea of what may be coming in and out will help you to ride the waves and prepare for any periods where cash flow might be an issue. If you see a problem coming, it is much easier to deal with it in advance than to wait until you suddenly realise you don’t have the cash to cover your costs.
You can keep track of your cash flow using a cash flow forecast. This is a simple spreadsheet that maps out what you think will be coming in and out of your business. It allows you to forecast how much your business may make over that period (usually made up to 12 or 24 months) but more importantly, it allows you to see how much money you will have and will need on a month to month basis and whether there are any months where your outgoings are greater than your income.
The benefit of planning ahead and using a cash flow forecast is that you can see in advance where you might have dry spells and deal with it before it becomes an issue. If you can see that in three months time you won’t have enough cash to cover your expenses to get you through to the fourth month, you have three months to find that money elsewhere, rather than suddenly being short and scrambling to fix it. If you stay on top of your cash flow forecasts and deal with problems before they arise it will be much smoother sailing
Be Smart With Your Credit Terms
One of the most obvious ways to help your cash flow is through your credit terms. If you are able to negotiate payment terms with your suppliers, take advantage of this. It might not seem necessary to begin with, but if you are able to get, say, 30 day payment terms from your packaging supplier, it allows you to look at your cash flow and decide when would be the most convenient time for you to pay that invoice, rather than it being due immediately, which could be a difficult time. Just because you have the payment terms doesn’t mean you have to use them, but it can come in very handy for situations like the above example, when you know you will have plenty of cash the following month to pay.
The other side of this is managing the payment terms for your own clients. If you are a small company just starting out, it’s best to try and avoid giving your clients credit at all if you can. Depending on who your clients are, this may not be possible. A lot of large organisations have set procurement systems that they must put invoices through, so 30 day payment terms are often standard for corporate clients. But for the individuals and smaller organisations it is best to insist on payment upon receipt of the invoice, if you are able. It’s harder to predict cash flow when you don’t know when your invoices will be paid, and as a small company there are less clients to balance the flow and the risk. If you allow payment terms on an invoice, there is more chance of that payment delay causing problems for your own operation.
IN A NUTSHELL: Try to get the longest possible payment terms from your suppliers and try to avoid giving payment terms to your own customers.
Keep a Buffer
A huge part of starting a business is bootstrapping and getting things going for the minimum amount of money possible. But as soon as you are able, try to start keeping money aside as a buffer, just in case any cash flow issues do arise. There’s nothing more frustrating than having a business that has real potential to work out, but just couldn’t get through a rough patch because of poor cash flow. If you use the cash flow forecast you can estimate roughly how much you will either be short or have left over each month, so you can use this to see how much of a buffer you might need.
Bring in Some Help
If you do find yourself shy of the funds you need, take some time to assess the situation. Look at your cash flow forecast – if (and ONLY if) you can see that the overall financial outlook is positive, and that the problem is cash flow, then it may be time to look at bringing in some help. Whether that’s a business loan or borrowing money from friends or family until you come out of the dip, just make absolutely certain that the problem is in fact just cash flow. If you are not bringing in enough money overall and can’t cover your expenses across a longer period of time, throwing more money at it will just mean an even bigger loss – so go through your financials with a fine tooth comb before making this decision.
Just Be Prepared
Keeping track of your cash flow is like having a crystal ball to see how things are going to go. It just allows you to equip yourself for what’s ahead. Whatever the situation, keeping a close eye on your cash flow should help you to be proactive with your financial decisions, rather than reactive, and will ensure the health of your business long term. Although it is just a forecast, and therefore about predicted figures, it can help avoid crisis, let you see problems in advance and ultimately save your business.
Download our cash flow forecast template here.
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