For small businesses hoping to flourish, there’s one major hurdle that everyone has to clear. A US Bank survey found that 82% of small businesses and startups failed at least in part due to poor understanding and management of cash flow.
This is tragic because cash-flow isn’t hard to understand. It just requires a slightly different kind of business thinking, with a strong focus on month-to-month or week-to-week liquidity.
Let’s look at four ways to avoid common cash flow mistakes that will help prevent your business from becoming just another statistic.
Analyze your cash flow constantly
The most important thing you can do for your cash flow is to get an accurate sense of what it actually looks like. This means performing consistent cash flow analyses.
A cash flow analysis will show you exactly how how much cash you having going in and out of your business during a specific time period. The analysis will begin with a starting balance and generate an ending balance once all cash receipts and paid expenses have been accounted for.
Doing this analysis will help you keep a pulse on how much cash you have access to at any given point, and help you prudently plan your spending.
Be active about getting paid
Your time is best spent on profit-generating activities, but that doesn’t mean that you should neglect the crucial task of making sure the debts your customers owe you are paid. Never confuse profitability with positive cash flow. Many small business owners make this mistake, which can leave them in a cash-flow pinch.
Unless your customers pay upfront in cash, all you have at the moment of sale is an unpaid invoice, which actually has a negative value since you no longer have the inventory, and you haven’t been given the cash yet.
So when you’re dealing with unpaid invoices, make sure you’re counting them as cash outflows. Although we instinctively want to count sales as cash inflows, an invoice should be counted as an outflow until it’s paid. After all, a percentage of unpaid invoices become bad debt.
If you find that your business is stacking up unpaid invoices, or that clients are paying them off at a leisurely pace, consider dedicating a member of your staff to being a full- or part-time accounts receivable clerk. Or explore your invoice financing options.
Don’t overestimate inventory or growth
Besides outstanding invoices, many small business owners make the mistake of confusing money tied up in inventory or growth projects with cash on hand. It’s easy to think of valuable inventory as adding to the value of a business, but until it’s sold and the invoice is paid, inventory is just frozen liquidity.
It can seem like a sound business plan to stock several months’ worth of inventory at a time, but this can actually damage your month-to-month cash flow solvency. Tying up your liquidity in inventory that you won’t be paid for in the near future limits your options and maneuverability.
The same goes for growth projects. It can be tempting to consider growth purchases like new vehicles or a new building as part of your company’s assets, but from a cashflow perspective, these decrease your overall liquidity. That’s not to say that you shouldn’t make these investments, only that you should look closely and make sure your cash-flow balance can support them.
Keep a (cash) cushion
Mistaking high sales or an overstuffed inventory for liquidity is a common mistake. There’s no substitute for a cushion of actual cash. Creating a buffer of liquidity is a great way to keep your business on track, especially if your industry experiences strong seasonal variations.
For example, if your snowboard shop hits yearly highs in December and January, examine your records and see how much you’ll need to cover non-fluctuating expenses like rent and wages during the summer months.. Roll your positive balance over without spending it until leaner times. Or keep it in a rainy-day account (out of sight, out of mind).
Be objective about your bank account
When dealing with cash flows, objectivity is the key to longevity. It’s about what you have and could spend today, not what your company is worth.
If you are honest with yourself about your liquidity and get in the habit of analyzing your cash flow often, you’ll stand a good chance of succeeding where so many others have failed.
Emily Kate Pope is a former editor at Fundera, a marketplace for small business financial solutions. Emily writes extensively on financing, accounting, and small business trends.