Cash flow can make or break your small business. And it’s not without its challenges; the average small business is paid 9 days late and 1 in 7 have been unable to pay employees due to cash flow issues. Add to this the fact that 80% of small businesses that fail do so because of cash flow problems, and you’ll see how getting cash flow right is key to underpinning your business’ growth.
In this guide, we’ll share how to manage cash flow in your small business, from understanding the basics to forecasting.
What Is Cash Flow?
In the simplest sense, cash flow is the money moving in and out of your business at any one time. You’ll have sources of income, such as sales, loans and investments. You’ll also have expenses you need to pay like rent, wages, inventory and utilities.
When you have a positive cash flow, this means your business has more money coming in that going out, allowing you to save and have more money in reserve. By contrast, a negative cash flow is where you’re spending more than you’re earning, a situation that won’t be sustainable for your business long-term.
Just like you might budget and save for your household, the goal with cash flow is to have enough money to comfortably meet expenses in your business, while allowing for future investment and growth.
This video by Harvard Business School explains the difference between cash flow and profit:
Why Is Cash Flow Important?
Understanding your cash flow is a key skill for small business owners. As we’ve seen, cash flow is the leading reason why businesses fail, even if they’re profitable.
As accountants, we’ve seen even outwardly successful businesses struggle with cashflow. While you may have excellent sales figures or growth, even a delayed customer payment or set of unexpected costs may cause you difficulties if you haven’t planned ahead.
Managing your cash flow can help you:
- Pay for expenses on time, from supplier invoices to payroll.
- Have the money you need to invest in growth opportunities.
- Have a financial cushion in case of seasonal or unexpected downturns.
- Build better relationships with your suppliers and lenders by paying on time.
If you’re looking to improve cash flow management in your business, our business advisory service can help you create a business to match your ambitions. We can also support you with management accounts to help you build a detailed financial picture of your performance.
Cash flow is the most common reason for business failure, making accurate bookkeeping and forecasting essential for understanding your business’ financial position.
How to Manage Cash Flow in Your Business
Gaining financial oversight of your business gives you the information you need to plan and budget effectively. When it comes to managing your cash flow, here are five tips we recommend for small businesses:
1. Prioritise Accurate Bookkeeping
Bookkeeping is an essential task for business owners. By accurately recording your income and expenses, you’ll have the data you need for financial statements and management accounts.
You can either use accounting software to do your own bookkeeping or invest in bookkeeping services if you don’t have the time. In both cases, your accountant can support you. Read more in our guide to 5 common bookkeeping mistakes to avoid.
2. Keep On Top of Your Invoices
It’s an unfortunate truth that more than a quarter of British SMEs are owed between £5,000 and £20,000 in unpaid invoices. If you’ve ever felt the stress of waiting for a late customer payment, you’ll know how important it is to send invoices immediately after providing your service or product.
Making sure your invoice is clear and makes payment easy, either by Bacs transfer or card, can also go a long way to getting your invoices paid quickly. If late payments are an issue, you may also consider asking for payment upfront, especially in the case of product sales.
3. Regularly Review Your Expenses
Keeping tabs on your expenses will help you stay aware of rising costs in your business, negotiate better deals, and make savings on products and services you no longer need. By setting monthly budgets for expenses, you’ll also have a clear understanding of how much you can spend in each area of your business.
4. Keep an Emergency Fund
According to the ERC, only 1 in 4 micro-businesses and 1 in 3 small businesses have over six months of cash reserves. Keeping an emergency fund can help your cash flow by providing a cushion in case of unexpected expenses and downturns in sales. It’s worth aiming to cover at least three months of operating costs, if not more.
5. Manage Your Inventory
In any business, but particularly product businesses, money may be tied up in inventory. To protect your cash flow, you’ll need to strike a balance between stocking enough to fulfil your sales, and not having too much left over.
When inventory is carefully managed, products and supplies will be used by your business and not stored for too long. This will help you free up cash for greater flexibility, as well as reducing the risk of overstock.
What Are the Benefits of a Cash Flow Forecast?
A cash flow forecast is a tool you can use to visualise future income and expenses in your business. Over a period of time, you can then identify any shortfalls or surpluses in your cash flow, allowing you to make strategic decisions.
For example, if you’re a retail business with a busy festive season, and you can predict a shortfall in autumn as you prepare, you’ll have more time to arrange finance, adjust your expenses or negotiate with suppliers to delay invoices.
On the other hand, a cash flow forecast may show a surplus, giving you the confidence to invest in new opportunities for your business, knowing you have the funds.
Lastly, it’s worth noting that accurate cash flow forecasting is essential for any business looking for funding. Your potential investors and banks will use this alongside your financial statements to assess your business.
Cash flow forecasting allows you to predict shortfalls and surpluses before they happen, giving you the time you need to negotiate with suppliers and arrange the finance your business needs.
How to Create a Cash Flow Forecast
Now we’ve shared the basics of managing your cash flow and the benefits of forecasting, here are five steps to help you create a cash flow forecast:
1. Set Up Your Spreadsheet
Start by defining the period you want to track. For example, if you’re forecasting for the year ahead, you may have a column per month. You can start anytime. Here’s a sample template you can use.
2. Add Your Income
Add your sources of income in the left-hand column. You can divide these into any categories that make sense for your business. For example, a florist may list product sales, wholesale, event sales and workshops. Under each month, you can then add the predicted income from each category.
3. Add Your Expenses
Make a list of all the regular expenses in your business. This might include anything from rent and salaries to stock purchases and marketing. As with income, add your predicted expenses throughout the year. Your expenses may be higher at certain times of year, for example when preparing for the festive season.
4. Calculate Your Net Cash Flow
In a row at the bottom, add your balance. Your opening balance can be the current amount of money in your business bank account, or you can start at zero.
Each month, the total of your income minus the total of your expenses is added to your balance. If you have a positive cash flow, you’ll see the balance increase and, likewise, a negative cash flow will decrease your balance. You can use this information to pinpoint any shortfalls or surpluses in the year ahead.
5. Keep Your Cash Flow Forecast Updated
Your cash flow forecast is only as useful as it’s updated. Each month, you can come back to your forecasting to add the actual results and compare them against your predictions.
Over time, this will help you make more accurate forecasts for your business. If you find something has changed, or your predictions aren’t accurate, you can always adjust your forecasts.
How We Can Help
We hope this guide has helped you understand how to manage and forecast cash flow in a small business. If you’d like to go deeper, download our guide to managing cash flow with tips for small businesses.
For more accounting tips for businesses, read our blog. You can also download more of our publications, including tax deadlines for limited companies, debt management strategies and a guide to personal tax planning.
When it comes to building a financial picture of your business, cash flow is just one element. At Lumin Accountancy, we provide tailored support to businesses of all sizes from management accounts to our advisory service.
Whether you’re starting out or preparing to scale your business, you can learn more about our business services here or contact our team to discuss your goals.
