The Ultimate Guide to Cash Flow Management for Small Businesses
I wish I had learned accounting & finance in high school instead of pre-calculus. Unfortunately, I didn’t, and understanding small business finances didn’t happen for me until I was getting my MBA. Sadly, for most business owners - learning about cash flow and financial analysis for small businesses doesn't happen until they’re building a business.
If you are a business owner - mastering cash flow management is one of the crucial steps small business owners can take to ensure long-term success. Cash flow issues are the number one cause of a business shutting down - ideas are great, but cash is what makes or breaks a business.
Why is it important?
Liquidity: Positive cash flow ensures you can meet daily operational needs. (AKA solid working capital)
Flexibility: It provides room to seize new opportunities without relying on loans or external funding. (AKA Cash Reserves)
Stability: Maintaining healthy cash flow minimizes the risk of insolvency during slower revenue seasons or unexpected downturns. (AKA predictable and diversified revenue streams)
Common Cash Flow Mistakes
Even experienced business owners can stumble when it comes to managing cash flow and that’s for one simple reason: cash is unpredictable.
Correction: how people deal with cash is unpredictable, because people are unpredictable. There will always be a customer who doesn’t pay - when you least expect and need it most. There will always be a potential client that says they’re all in, but then ghosts you. There will always be an unexpected expense, or tax bill, or business investment you weren’t planning on when you did your 12 month budget. There will always be an unexpected price increase when you thought it all had it sorted.
Here are a few things I’ve experienced in my clients’ businesses and even own business:
Letting payments from customers go unpaid - just today, I reviewed my cash flow and noticed a customer payment had failed 5 days prior. Not all payment systems have the best alerts, and trust me- if your payment fails it’s unlikely your customer is going to notice before you do!
This was an easy fix, I let the customer know - they fixed it - problem solved. That doesn't happen for everyone. A few things you can do to mitigate this: have clear policies on what happens if payments fail and customers do NOT correct the issues. Review your payments regularly to make sure there aren’t any outstanding.
Managing expenses with a team can lead to a lot of issues if your business doesn’t have a process or approval system. You MUST have guidelines in place to make sure all team members know what’s expected, how to handle expenses and prevent mismanagement.
Not having a budget - 90% of the business owners I talk to (before they hire a CFO) do not have a budget. Without a budget you don't have a plan and cannot make informed decisions
Not saving for taxes
Key tip: open a savings account just for taxes, move money to that account each month and only use it to pay taxes,
Taking on too much debt
Debt should be used to accelerate growth. Taking on debt to cover cash gaps often leads to more problems than solutions. Debt payments can eat cash flow.
Not focusing on sales
All businesses need good sales strategies and implementation. More often than not cash flow issues are a result of not focusing on sales
Cash flow management is much more nuanced than simply relying on revenue to come in before expenses go out. If you want solid cash flow, you’re going to need a few key ingredients:
The right business strategy
An understanding of how to manage cash
Working Capital
Cash Reserves
A solid budget
The right bookkeeping setup
The right mindset
Business strategy is nebulous and confusing, but ideally, you have: a core product with good margins, a sales & marketing plan where you are pushing to get at least $3 back from every $1 you spend on marketing & sales, some type of recurring revenue, and some diversification that keeps revenue coming in even when there is seasonality in another product or service.
Understanding how to manage cash is key.
You need 3 key things:
Working Capital - this is the cash needed to cycle through the business each month
Cash Reserves - I recommend 3 buckets: taxes, emergency funds, and investments
A solid budget - keeping a budget updated allows you to forecast your cash flow needs and keep track of your expenses so you don’t overspend.
To dig in deeper check out my prior article that goes into detail on the cash management triangle– you can read it here.
The right bookkeeping set-up can make or break your cash flow. Having up-to-date financial statements allows you to increase the accuracy of your forecast and let you know where you’re spending the most $$ and if you’re getting the ROI you expect. For most businesses (99%) I recommend getting a good outsourced bookkeeper to do a monthly close and provide financial statements. Reach out to me for my favorite recommendations!
The right mindset. Managing small and growing business finances is very different from personal or corporate finance. Typically personal finance management only looks at what you’re spending and saving. Corporate finance is a “set-up the budget’ and report up the ladder method. But when you’re a small and growing business you need to think through exactly how each dollar spent will impact revenue. There’s two ways that money can impact revenue: directly increase revenue (think google ads) or create efficiency and increase margin (think outsourcing support to an expert or buying in bulk). When you frame up your money spending mindset this way it’s much easier to manage cash flow and think strategically.
Improving Cash Flow
Business owners struggling with cash flow tend to start by drastically cutting expenses and calling it a day. This can be incredibly damaging to your business. Cutting too many expenses can limit your ability to increase sales and keep you from making strategic investments in long term growth. I've helped several clients extend their runways and reduce expenses and occasionally we over do it at the detriment of revenue. Without revenue, you don't have a business, sometimes the cash flow problem isn’t actually cash, it's that you’re not focused on generating revenue.
Some of the the root of cash flow problems:
Too few sales
Too many unnecessary expenses
A hire that doesn't add efficiency
Lack of strategy
Ignoring your finances and not paying attention to what’s happening in your business
I recently had a project based client with cash flow issues. I dug into their prior 12 month financials only to realize that yes that had cash flow problems that could be fixed- but the bigger issue was they had almost no sales & marketing strategy so when they lost a few clients it completely decimated their revenue source and there was no line of sight to increasing revenue. They actually didn’t have an “overspending issue”, they had an “under-investing in the right things issue”. We created a budget, primarily focused on the next 3-6 months, cut costs where we could (mostly owner pay) and then I told them to focus as much time as they could bring in new business before increasing any additional expenses.
Fixing your particular cash flow issue is much more about finding the root cause, but there are many things ALL businesses can do that help create more predictable cash flow:
Stay on top of your AR - check it weekly and reduce your term length where you can
Get paid in advance or at time if service
Set-up a recurring payment system (I like Plooto for service based business)
Create product diversity that smooths cash flow
Have a budget & cash flow plan - Finance Fight Club members get access to my templates and we have a great budget & cash flow template
Look at cash weekly, forecast monthly
Understand your working capital - Grab my guide here!
Build cash reserves
When to Seek Help from a CFO
Managing cash flow effectively can be complex, especially as your business grows. A fractional CFO can provide expert guidance without the cost of a full-time executive. A good CFO will build a long term cash strategy and correct and short term issues. They are your guide to making smart informed decisions on how to use your cash to generate revenue and provide financial analysis for small businesses. Seek them out before you're struggling with cash to help you plan ahead, when you're seeking financing of any kind, and when you start to foresee any cash issues.
How Can a Fractional CFO Help?
Strategic Planning: Develop and implement sustainable cash flow strategies tailored to your business goals.
Financial Analysis: Conduct deep dives into your financial data to identify trends and opportunities.
Process Improvement: Streamline your bookkeeping and reporting systems to enhance accuracy and efficiency.
Risk Management: Identify potential financial risks and develop strategies to mitigate them.
If your business is struggling with cash flow management, or if you simply want to take your financial strategy to the next level, consider reaching out to a fractional CFO for support.
Effective cash flow management isn’t just a financial necessity—it’s a cornerstone of sustainable growth. By understanding the nuances of cash flow & cash flow management, avoiding common mistakes, implementing strategic improvements, and utilizing CFO for support you will be on the right track to scale your business.
Ready to take control of your cash flow?
Join Finance Fight Club and stay accountable to your business goals with the support of fractional CFOs along the way.