Cash Flow for Small Business


Executive Summary

  • Net Income does not equal Cash Flow
  • Collect revenue as quickly as possible
  • Pay your expenses as slowly as possible
  • Use lines of credit to cover short-term cash shortages

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Cash Flow is the life line of your business and understanding what it is and how to maximize it is crucial.

Net Income (or Profit) is your Revenue less Expenses. Cash Flow equals Cash In less Cash Out. So what makes them different? If the revenue is not received in cash at the time it is accrued (or recorded), you’ll have Revenue, but no Cash in. If you pay a bill on a credit card, you reduced your net income, but not your cash. Cash flow also includes some items not on your Income Statement, such as payments on loans, which clearly decrease your cash.

And which do you think is more important to the survival of your business? Cash flow. You cannot operate a business without cash. Even if you are profitable, your business will fail if you run out of cash. Let’s look at some cash flow examples.

Scenario 1 shows us a negative cash flow situation where you are spending cash before you receive it.

Negative Cash Flow Scenario

The amounts involved and the time duration determine how serious your cash flow situation is. If it’s three months and several thousand dollars, it is much more serious than a few hundred dollars over a few days.

Scenario 2 shows us a positive cash flow situation where you are receiving cash before you spend it.

Positive Cash Flow Scenario

In this case, we didn’t spend any cash before we received it and we held on to the cash for some time.

Collect your revenue as quickly as possible. The best scenario is to receive payment before or at the time the product or service is provided. Unless you are selling a commodity service or product with lots of competition, you can decide to require payment immediately. If a customer wants your unique product or service delivered with your impeccable service, they can pay you at the time you deliver (or even before).

However, your industry or competition may require that you offer terms, invoicing for your product or service after it is provided and offering a period of time to pay, often 30 days. You could set your time to pay to be shorter, say 15 days. But be forewarned, 30 days is what most customers are accustomed to. If you want them to pay faster, you will have to train your customers accordingly, which requires discipline and effort on your part to be a diligent collector.

You can accept credit card, Paypal, or Venmo payments, but I would argue that it doesn’t make the customer pay much (if any) faster. Customers only pay faster if you demand that they do. And accepting credit cards or other payment services will cost you up to 3% of your revenue. You may have to offer these payment methods, but be sure your pricing includes this additional fee.

Zelle is a service which provides bank account to bank account transfers and is free for both sender and receiver. Check with your bank to see if they are participants in the Zelle network. Zelle payments are instantaneous, hitting your bank account almost as quickly as it leaves your customer’s account (during normal business hours).

Bill.com and Quickbooks Online offer not only customer invoicing, but payment services as well.  These services include bank transfer payments, commonly known as ACH payments. You pay a subscription for the software, but I believe both offer free ACH transfers. Be aware that ACH payments take 24-48 hours between banks and services like Bill.com add another 2 days to that process.

My personal favorite collection tool is the ACH debit. Bill.com also lets you initiate the bank transfer, which removes control from your customer altogether. To comply with banking regulations, you do need to have a signed ACH debit agreement with your customer. And it works best when you pull the money on the same day each month if it is a recurring charge or you give them 5 to 8 days notice that you will be pulling the money for a one-time invoice.

Pay your expenses as slowly as possible. If your vendors will extend terms to you, use them. This can buy your 30 days of cash. Even better, if your vendor accepts credit cards as payment, use their 30-day terms, pay them with a credit card and extend your time to pay by up to another 45 days (depending on your credit card’s billing date and payment due date). If you pay your credit card in full at every due date, you won’t pay any interest charges.

If you get into a serious cash crunch, you can push a vendor beyond their terms. But please give them a heads up. They are expecting that money, just like you expect your customer’s, and they need to know you will be paying late. I recommend sucking up your pride, calling or emailing the vendor, explaining your have a short-term cash issue and asking permission to extend the invoice terms another 30 days. If they agree, make sure you comply with the extended terms. And don’t abuse that vendor’s terms over and over again- make sure it is only when you really need some relief.

If you carry inventory in your business, that can be a huge pit that cash falls into and sometimes never comes out. Managing inventory and cash flow is worthy of much more detail that I can offer here, but just recognize that inventory ties up your cash and needs to managed closely.

Sometimes accelerating revenue collections and pushing out payables isn’t enough and you will need to have a line of credit to offset cash shortages. A line of credit is much like a credit card with a set credit limit, however, you request cash advances on the line when you need it, sometimes incurring an advance fee. A line of credit will charge you interest, so it increases your expenses.

A line of credit is available through your bank or you will find several vendors online offering lines of credit. Credit Karma and Lending Tree will show you multiple lender offers for you to consider. You can also check on the lender sites Paypal.com and SoFi.com for lines of credit. And honestly, it doesn’t need to be a “business” line of credit, because any lender is going to ask you to personally guarantee the loan, so a personal line of credit achieves the same purpose. Business or personal, the lender will pursue you personally for repayment.

Use your line of credit for cash flow shortages and then pay it back. You can only use your line of credit if it has availability (credit limit less borrowings). Banks, particularly, like to see the line of credit balance return to zero over the period of the loan, usually a year. If you find you are using your line of credit for long-term purchases, work with your lender to convert the balance to a traditional term loan that you can pay off over three to four years.

Cash flow is the life line of your business. Pay attention to it and manage it as closely as you manage your net income.  I might argue it deserves even more management.

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