The Difference Between Cash Flow and Profit
Cash flow is more than just the money your business makes. It’s your income minus any expenses you’re incurring, including interest you’re paying on debt.
Remember that income will not automatically flow in alignment with your expenses to avoid cash flow problems. Your due date for your customer invoices is independent of when you must pay regular expenses, whether it’s rent for your office space or meeting payroll obligations. In flush times when income outpaces expenses, save as much as possible. One of the other most critical methods of solving cash flow problems is to have a three-month buffer in place so costs can be paid when money is too tight to mention.
Small businesses can find themselves unable to operate without a financial cushion in place – it doesn’t matter that several customer invoices are due a month from now if you can’t pay your employees or fund regular business operations. While it does make sense to have access to a business line of credit, you don’t want to rely on it too heavily to solve your cash flow problems. You may discover you’re maxed out and still can’t pay your bills.
Avoiding cash flow problems means always knowing how much your customers owe you, what you owe to your suppliers and recurring operational costs such as payroll, rent, utilities, and any potential shortfalls. The best way to avoid shortfalls is to make sure your customers are paying on time, and if they’re not, have a plan to get paid. Having many customers on paper is meaningless if they’re not paying their bills.
Mistakes That Lead to Cash Flow Problems
Not maintaining cash reserves is probably the most common cause of cash flow problems for small businesses. Depending on the nature of your business, it may not see a flow of income that outpaces expenses until six to eight months.
Another cause of cash flow problems is spending too much money upfront when launching your business. While you want to be optimistic about your long-term success, one of the best methods of solving cash flow problems is not committing to regular expenditures you don’t really need in the early days, such as a long-term lease on office space. Instead, maintain a home office a little longer or look for shared workspaces. You can avoid cash flow problems by separating what your business really needs from what is nice to have.
Ideally, you should be watching for cash flow problems daily or at least once a week. However, for a small business, every transaction matters. A small number of customers can make up the bulk of revenue, so one of the essential methods of solving cash flow problems is making sure all customers pay you as soon as possible. You can accomplish that by making it easy to pay you and having someone responsible for tracking receivables.
Hiring an accountant, even if only part-time, will help you avoid cash flow problems. Someone who can help you manage your money correctly will allow you to have a precise picture of your financial health, including cash flow. They can also help you plan and forecast and make sure you’re meeting your tax obligations without overpaying. If hiring an accountant isn’t possible presently, you’ll have to play the accountant’s role and manage the books yourself.
As a small business owner, it’s easy to fall into being “penny wise but pound foolish.” Paying a financial expert is money out of pocket, but an “ounce of prevention is worth a pound of cure.” An alternative to hiring an accountant is finding a bookkeeper to help. For example, should your business ever be audited by the Canada Revenue Agency, a bookkeeper will save you time and money with their thorough understanding of small business taxes. Meanwhile, a financial planner can help you set aside budgets for strategic capital expenditures that can help you grow your business.
Spend Money to Save and Make Money
As much as you don’t want to spend too much too soon on big-ticket items, like a 10-year lease on office space, pinching pennies by putting off necessary expenditures can prove costly. For example, refraining from upgrading computing systems could cost you more in the longer term. It can reduce employees’ productivity and halt business operations if your existing system crashes and leaves critical business information inaccessible. Similarly, you want to equip yourself and your employees with the necessary software tools and other equipment to be competitive in your industry.
Another expense you may be tempted to avoid because you think it will abet your cash flow problems is paying for appropriate and adequate business insurance. At first blush, you might think having liability insurance is just money going out the door but paying a predictable monthly premium can help you avoid making a big payout you can’t afford. Small businesses and solo entrepreneurs are just as data dependent today as larger enterprises, and insurance products such as cyber liability insurance are an excellent investment.
Suppose a hacker tricks one of your employees into clicking a malicious link that gives them access to your backend data, including your clients’ financial information. In that case, among the things cyber liability insurance covers is restoring your data, repairing your computing systems, and providing your clients with credit monitoring. Similarly, business interruption insurance can help you recover your losses resulting from an insurable event, such as a fire, theft, or windstorms.
Avoiding cash flow problems is not as simple as making more than what you’re spending so you have a healthy profit margin. It’s also about making strategic investments to prevent unexpected charges, grow the business, and keep existing customers happy.