Startups often burn cash as they grow. The key is to 1. Not panic, but 2. Not get too comfortable with bleeding cash.
And this makes cash flow management a must-have skill for founders and entrepreneurs.
You need to be able to navigate periods of thin, nonexistent and even negative cash-flows efficiently. Your business will have times where it struggles with profitability. Whether that’s during your early, pre-revenue stages or when a pandemic forces you to close up shop.
This article is a comprehensive guide to cash flow management and will show you everything you need to consider as you lead your business towards further profitability.
Let’s get started.
Annual revenue is often the first metric used to demonstrate business success. Business owners throw that number around on their website pages, in their advertisements and at networking events.
But having high revenues doesn’t necessarily translate to having tons of cash.
There are a lot of steps between booking your revenue and taking that money to the bank. Not least of which is collecting on your receivables.
Optimizing Accounts Receivable (A/R)
One of the best ways to increase your cash flows without making any additional sales is to improve your accounts receivable function.
Here are some strategies to consider:
- Automate Your A/R Aging: It’s best practice to track your outstanding receivables using buckets of roughly 30 days. Aggressively pursuing each account can be tedious, so it’s best to automate your treatment of each bucket. Create templates of payment reminders that you can send out to customers automatically at each point in the aging process.
- Require Online Payments: Letting clients pay with old fashioned methods can be a hindrance to your business. No one has time to wait for cash or checks in the mail anymore. If you haven’t implemented mandatory online payments, notify your clients that you’ll be making the change a few weeks in advance. Then switch to modern methods and never look back.
- Flexible Payment Plans: Your business isn’t the only one concerned with managing its cash outflows. If your clients are struggling to make ends meet, consider allowing flexible payment plans for debts older than two months. After all, collecting part of your receivables is better than nothing.
- Early Payment Discounts: To encourage good behavior, consider offering your customers a discount for paying on time. Offering 2% for payment within ten days is common, but you can play around with this to find the right balance.
These are all great ways to boost your cash flows. But incoming cash is only one half of the equation. Next, let’s take a look at some strategies for minimizing your expenses.
Controlling Your Costs
You’ve probably heard the cliche: “You need to spend money to make money.” That unhealthy idea has caused nothing but heartache for well-meaning business owners over the years.
The truth is that aggressive spending is always a risk, and often an unnecessary one. You should always be looking for cheaper ways to accomplish your goals.
To help organize your efforts, break down your expenses into two groups:
- Cost of goods sold (COGS): the expenses that go directly into creating your product. This includes direct labor, direct materials and any allocatable overhead.
- Operating expenses: the expenses that keep your business operations running, like marketing and payroll costs.
The lower you can get these costs, the more of your revenue you get to keep. And there are tons of effective strategies for reducing your COGS and operating expenses.
Here are a couple of great examples:
- Negotiation: There are more opportunities to negotiate potential discounts than you might think. Suppliers are a great place to start. Your relationship is long-term and multi-transactional, with the potential for massive savings over time.
- Strategic Advertising: Not all marketing strategies are worthwhile investments, and many of the most expensive ad campaigns provide no identifiable return. Use the advertising methods that verifiably bring in business while costing you the least (like inbound marketing and referrals).
A Deeper Look at the Numbers
Speaking of return on investment, you should also pay close attention to the effect that your cost-cutting strategies have on your cash flows.
Here are some helpful metrics you can use to track your progress:
- Gross Profit Margin: (Revenues – COGS) ÷ Revenues. This percentage shows how much of your revenues go towards preparing your product for sale. Compare your gross profit margins to other competitors in your industry. If you find that your gross profit margins are significantly lower, take the opportunity to look for cheaper suppliers or more affordable labor.
- Net Profit Margin: Net Income ÷ Revenues. This percentage shows how much of your revenues you take home at the end of the day. In addition to comparing your net profit margins to your competitors’, study it in light of your gross profit margin. If your gross margins are healthy but aren’t leading to the profits you hoped they would, revisit your operating costs.
Maximizing your profit margins is a great way to boost your cash flows, but other costs are also competing for your dollar. Let’s take a look at the role that debt plays in managing your cash flows.
Be Cautious with Debt
Many businesses need external funding to build their business initially, and debt is often the solution of choice. It’s more flexible, cheaper and lets you avoid giving up interest in your company.
But there’s a fine line between useful leverage and crippling debt payments. And you’ll want to stay well clear of the latter.
If you do have to take on debt, here are some best practices to minimize the risk to your cash flows:
- Keep a low debt ratio: Your debt ratio is equal to your debts divided by your assets and is a common way for lenders to gauge the risk of lending to you. Theoretically, your company can always liquidate its assets to cover its debts in an emergency. Hold assets far greater than your liabilities to keep that option available.
- Shop around for the lowest rates: This is another area where negotiating can pay off significantly. Even a slightly lower interest rate can save you thousands of dollars on a large loan.
- Avoid inflexible debt sources: Before committing to a long-term, rigidly scheduled loan, look into your other options. Try to avoid taking on recurring monthly payments when you don’t have to. For example, a line-of-credit that you can access only when needed and pay back quickly is less dangerous to your cash flows than a business loan.
Now we’ve covered the entire cash flow cycle, so let’s discuss some ways you can get started today.
How You Can Start Today
If you close your receivables quickly, control your costs and keep debt to a minimum, then your business will be well ahead of its competition. Unfortunately, all of those strategies take time to implement.
But there is some planning you can do today that will lead to better cash flow management in the future. Like they say: a plan is nothing, but planning is everything.
So study your history, analyze the trends and develop a plan of action. Take some time to analyze your current monthly cash flows and calculate how long your reserves could support you in an emergency.
Find the areas of your business that need the most work, and you’ll be well prepared to add value to your cash flow management as soon as possible.