What scares a small business owner more than anything else?

For most, it’s running out of money. Owners fear not having enough cash flow to cover payroll and pay expenses.

It’s cliché because it’s true:  cash is king.

That’s why businesses need to have a cash flow management process in place. The way to avoid this headache is to have positive cash flow. Doing this requires being proactive and smart about cash management.

Money management begins with understanding cash flow 101. Many entrepreneurs and small business owners don’t know as much as they need to about cash flow and managing it.

The more they know, the more business owners can cut the time spent putting out fires in dealing with financial management issues.

Let’s start with a definition.

What is cash flow?

Cash flow is the movement of money in and out of your business. Money comes in through accounts receivable in which customers pay their invoices. Money goes out through accounts payable as the business pays expenses and covers payroll.

What is a cash flow problem?

Simply put, more money goes out than comes in the business. It’s possible for a business to show profit on paper or in spreadsheets and yet not have positive cash flow.

What causes cash flow problems?

Here are six reasons a small business could run into cash management issues.

1. Letting clients take too long to pay their invoices.

Your business may be producing many invoices, but clients are taking 30, 60, or more days to pay your accounts receivable. Allowing clients to take an indefinite amount of time to pay puts you in a bind that you can’t pay your expenses or accept new opportunities. If you’re working with clients who struggle to pay on time, you might want to try these seven tips to stop late payments.

A good way to stay on top of your older invoices is by creating an accounts receivable aging report. This report shows unpaid invoices that are past overdue. You’ll know which clients you need to contact to get the invoice paid. Here are three ways to stay on top of your accounts receivable.

2. Working with clients who can’t pay.

Have you considered checking clients’ credit before doing business with them? If they won’t work something out, maybe it’s time to fire the client. Some businesses may want to require full payment or a deposit up front before starting any work or delivering products. This puts money in your bank account and cuts down chasing payments. You also avoid doing any work without pay.

3. Struggling to balance invoice payments and paying bills.

Most expenses have a standard due date. Your credit card, for example, may be due on the 20th of every month. If you send your invoices at the end of the month, you may run into a timing problem. Payments may not come in time for you to get the cash to pay your credit card bill on time. This simple example shows how cash flow management relies largely on the timing of receiving payments and bill due dates.

A good way to manage this is to create a documented accounts receivable process. This process outlines when you invoice clients, who sends the invoices, and who communicates with clients. It’ll help ensure nothing gets overlooked.

4. Growing too fast.

Opportunities to take on bigger jobs keep popping up, but you don’t have the cash to cover these additional costs. It’s a catch-22. Either you need to tap into cash reserves or secure financing from elsewhere. And that brings up the next point.

5. Having little or no cash reserves.

The typical recommendation is that companies should have enough cash reserves to maintain business for six months. Every business needs to make it a priority to build up cash reserves so it never has to worry about paying employees and vendors. No business wants to turn away new opportunities because it doesn’t have enough money to support the work.

6. Seeing profits drain too quickly.

It won’t matter how much cash reserves a business has if it doesn’t identify what’s eating the profits. Producing a cash flow statement on a regular basis can help management figure out the source of the drain.

Comparing a cash flow statement to actual figures can highlight problem areas such as paying higher monthly fees for phone service than forecasted. Could the phone bill be lowered? Can you find a plan that better fits your business? Is it time to adjust the cost of phone services and cover them by raising prices?

How can a business owner fix financial management problems?

Aside from the aforementioned suggestions for solving cash management problems, the other cure is raising money. The finance process is a bumpy one when working with a business bank. The good news is that there are different types of loans and financing options.

If you have aging invoices, you might be in a good position to get money for your accounts receivable. This flexible financing is referred to as factoring or invoice financing. Using this, your business will be able to take advantage of new opportunities that will propel you ahead of your competitors.

Factoring improves your cash flow and credit rating. You can also use it to get supplier discounts as you’ll be able to buy in bulk. Here are 10 reasons factoring may be a financing option for your business.

Unlike most bank loans and other financing sources, factoring looks your clients’ financial strength and credit worthiness. Not your company’s. Best of all, there’s nothing to pay back like with a business loan.

Image source: Christopher Alameda