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Everything You Need to Know About Cash Flow

Manage Cash Flow

One of the most fundamental principles for a business’s success is also one of the most neglected—especially by new entrepreneurs who are often distracted from being focused on big-picture finances. Cash flow, or the measure of the amount of money being transferred in and out of your business, can ultimately make or break your organization—regardless of how profitable your business is on paper. While conceptually simple, launching and executing a cash flow management strategy can be tricky even for financially experienced organizations.

In this guide, we’ll do a deep dive into the nature of cash flow, and how you can manage it effectively.

Why Cash Flow Matters More Than Revenue

It’s hard to say that cash flow matters “more” than revenue, since both are defining financial metrics for your organization. However, revenue, and even your net profit can be high while cash flow suffers—and if your cash flow creeps too far into negative numbers, you may never fully recover.

This is an important realization; it’s possible to generate a lot of sales, and even have an on-paper profit, while cash flow is nonexistent. For example, let’s say you’ve made $150,000 in sales this month, but you’ve also incurred $130,000 in expenses, which you’ve paid in full. Hypothetically, this represents a $20,000 profit, but what if your customers have only collectively paid $50,000 of their $150,000 in bills? That means $100,000 of your sales have not yet become cash, which puts you $100,000 behind; if bills keep coming in, your resources may be stretched too thin, and your business may not be able to withstand the pressure.

Cash Flow Statements

Most businesses measure and report on cash flow with the help of cash flow statements. These balance sheets function much like other types of financial reports, tracking income and expenses, but they focus on actual cash gain and lost; for example, if you’ve issued an invoice, you won’t track it as cash flow income until you’ve actually received payment from your customer.

You’ll track cash flow in three main areas:

  • How have you spent and made money in operations? Which clients have paid their invoices? Which bills have you paid?
  • How have you made or lost money from investments? What have you measurably paid, and what types of dividends or sale proceeds have you made?
  • Has your business raised funds from investors, or have you issued dividends that have decreased your cash levels?

Analyzing cash flow statements and taking proactive action are two of your greatest chances for keeping your business’s cash flow healthy.

Your Main Priority: Tracking Cash Flow

Obviously, your business needs to take cash flow seriously, and improve it however possible without jeopardizing the rest of the business. Your first step, and highest priority, should be aggressively tracking your cash flow. Tools like Datapine’s finance dashboard are all-in-one platforms meant to help you track your company’s finances at every level, and they can help you keep an eye on your cash flow on a regular basis.

Depending on the size of your business, you’ll likely want to measure and report on cash flow on at least a weekly basis, if not a daily basis; that way, you can proactively identify key threats and/or opportunities, and capitalize on them before it’s too late.

Free Cash Flow vs. Operating Cash Flow

You should also know there’s a difference between free cash flow and operating cash flow. Operating cash flow refers to your cash flow on the basic level; how much money are you generating from product sales and paid invoices, versus how much money are you spending for employees, rent, and other typical business expenses. This is similar to calculating profitability, but only refers to realized income and expenses.

Free cash flow, by contrast, includes dividends and investments in your calculations. Free cash flow takes your operating cash flow and subtracts dividends you’ve issued to investors or owners, and represents a truer indication of your financial position.

Increasing Cash Flow

Generally speaking, a higher, more positive cash flow is better for your business. There are several strategies you can use to keep a positive cash flow:

Designate a cash flow manager.

It’s much easier to keep an eye on your cash flow and take action when necessary if you have someone directly responsible for it. Rather than waiting to look at your financial statements until the end of the month, or trying to do everything yourself, designate someone on your accounting team to be specifically responsible for overseeing and managing cash flow. This doesn’t have to be their only responsibility, but it should be one of their main ones.

Limit expenses.

This is a somewhat obvious, but important strategy: limit your outgoing expenses, especially if cash flow is starting to get tight. If you can avoid paying for something, do it. Frugal businesses naturally have better, more consistent cash flow than ones that spend indiscriminately.

Increase revenue.

Similarly, you can increase revenue. It may seem obvious to recommend any business increases revenue, but it can really ease the burden of cash flow management if you have sources of consistent income.

Diversify revenue.

Even if you have an impressive stream of revenue, there’s always a chance that stream could dry up. Accordingly, it’s also important for your business to diversify its streams of income, just as you might diversify an investment portfolio. If you make money in many different ways, you’ll never be overwhelmed—and your cash flow won’t be jeopardized—if you suffer losses in any one area.

Credit check clients.

Non-payment from clients can be debilitating. A simple way to prevent or mitigate this problem is to credit check all your clients proactively. If you’re working with someone who is a known or historical credit risk, set strict payment terms or get payment upfront.

Set strict payment terms.

Even with reputable clients, it’s a good idea to set tighter payment terms on your invoices. If clients are paying you within 10 days, instead of 30 days, you’ll have a more consistent line of cash coming in.

Delay outgoing payments.

Conversely, you can keep more cash on hand at all times if you wait until the last possible day to pay all your outgoing invoices. The only exception here is if there’s a monetary penalty for waiting; in these cases, your best course of action is to delay payment for as long as you can without penalty.

Follow up on unpaid invoices.

Inevitably, you’ll run into a client who cannot or does not pay their invoice by the deadline. It’s vital for you to have a follow-up strategy in place for these clients. Get an alert whenever a client misses a deadline, and follow up with them firmly but politely. Continue following up, offering different payment options and using different contact mediums, until you receive a payment.

Cash Flow Is Tight. Now What?

If cash flow starts to get tight and/or your proactive strategies aren’t working, there are a few next-level tactics you can execute to restore your cash flow:

Open a new line of credit.

It’s a short-term measure, but one that can afford you more financial flexibility. Consider opening a floating line of credit that you can tap into whenever necessary; it can help you close the gap between client payments or afford you more flexibility when making a new investment.

Aggressively pursue payment.

If clients continue to avoid payment, step up your efforts. If clients become nonresponsive, or uncooperative, you may need to take legal action to get the money you’re owed.

Negotiate with clients.

If you’re eager for payment and you know the client is unable to pay, consider negotiating with them. Taking 20 percent off, or splitting the invoice into smaller, regular payments isn’t ideal, but it’s much better than simply taking the loss.

Slash operating costs.

In times of desperation, you may consider temporarily slashing your operating costs. For example, you could lay off some of your workers, reduce your workload, or make other cuts to get through a tough period.

Factor your invoices.

If you have lots of unpaid invoices, you can consider factoring them. Essentially, the idea is to sell your unpaid invoices to another party. This sale is usually for a fraction of the total value of the invoice. Then, the third party will follow up to collect payment. Again, this isn’t ideal since you’ll be getting less than the total value of the invoice. But, it’s better than nothing if you need cash.

Reorganize the business.

If your cash flow is consistently negative and you don’t see a route for recovery, your only option left may be to reorganize the business. If you do this, you’ll analyze and overhaul your strategy, setup, and financial operations. You may also reorganize your assets and debts to make a financial recovery.

Achieving Good Financial Order

Cash flow is a confusing and intimidating concept to new business owners, but once you have it under control, you can rest assured that your business is in good financial order. As long as you understand how cash flow works, you have a good cash flow reporting system, and you’re willing to work proactively to keep your cash flow positive, you should never find yourself in a desperate position.

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Peter Daisyme is the co-founder of Palo Alto, California-based Hostt, specializing in helping businesses with hosting their website for free, for life. Previously he was the co-founder of Pixloo, a company that helped people sell their homes online, that was acquired in 2012.

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