How to master your cash flow and maximize your profits
Tue | July 2023
'Cash is king!' Every small business owner is likely familiar with this mantra. And while it may seem like a cliché, the reality is that cash flow is truly the lifeblood of your business and a critical element to maximizing your profits. Did you know 82 percent of companies fail due to poor cash flow management?
Simply put, cash flow is your business's heartbeat, dictating its vitality and viability. Cash flow management it's the rhythm of money moving in and out of your business, vital for everything from covering daily expenses to investing in growth.
In this comprehensive guide, 'How to Master Your Cash Flow and Maximize Your Profits,' we'll guide you through the essentials of cash flow, from understanding its nature to mastering its management:
Cash flow in small businesses
Analyzing and calculating your business's current cash flow
Is cash flow the same as profit?
Ways to improve your business cash flow
We aim to equip you with the knowledge and strategies to boost your cash flow and, ultimately, your business profits. Ready to turn your cash flow into a powerful tool for growth and sustainability? Let's dive in!
What is cash flow in small business?
Cash flow in business refers to the net amount of cash and cash equivalents transferred in and out of a company. It's crucial for operations, as it pays for expenses, provides investment opportunities, and indicates financial health. Positive cash flow means income exceeds outgoing costs.
We can break down cash flow in businesses into three components:
Cash flows from operations (CFO) come from the core business operations. It includes revenues from selling goods and services and the cash spent on production, marketing, and other operating expenses.
Cash flows from investing (CFI) pertain to cash spent on investing activities such as purchasing or investments and money received from selling such assets or investments.
Cash flow from financing (CFF) reflects money flowing between the company and its owners, investors, and creditors. It includes issuing shares or debt, repaying loans, and distributing dividends.
For more information about the three types of cash flow that your business can have, see: How to calculate your cash flow with three different formulas.
How to calculate and analyze your business's current cash flow
For your business to thrive and grow, it's essential to understand your current cash flow situation. This knowledge helps you determine whether you're generating enough cash to meet your costs and where exactly your money is going.
A Cash Flow Statement is a practical way to assess your current cash flow. A cash flow statement breaks down the cash inflows and outflows into three categories:
Operations: The cash related to your day-to-day business operations.
Investing: The cash used or gained from buying or selling assets.
Financing: The cash involved in loans or investments.
You can also use the Operating Cash Flow (OCF) ratio to calculate your cash flow. The OCF ratio is a measure of a company's financial health. It compares operating cash flow (income from regular operations, excluding investments and financing) to current liabilities, indicating a firm's ability to cover short-term obligations.
A high OCF ratio generally signifies solid financial stability. The formula for calculating the operating cash flow ratio is as follows:
Operating cash flow ratio = Operating cash flow/current liabilities
If your OCF ratio is less than 1, it suggests your business might have trouble meeting its short-term debts. A negative OCF ratio means you may need to find ways to bring in more cash or reduce expenses (we'll cover this in the following sections).
Is cash flow the same as profit?
No, the two metrics are very different from one another.
Think of cash flow like your business's wallet. It's all about the money coming in (from selling products or services) and going out (to pay for things like rent, supplies, and salaries).
Profit, on the other hand, is like the leftover money at the end of the month. After you've paid for all your business's costs, like rent, supplies, salaries, and other expenses.
When understanding the difference between cash flow and profit, you must know that your business can be profitable but still struggle with cash flow. Let's say you own a small furniture store, and you've sold many high-end furniture pieces to a couple of interior design firms. Your profit margins on these sales are excellent.
However, these firms operate on net-60 or net-90 payment terms, which means you won't receive the payment for these sales for two to three months. In the meantime, you must pay your suppliers, employees, rent, utilities, and other expenses; this is where the cash flow problem may arise.
Despite having profitable sales, the delay in payment from your customers could cause a cash crunch, making it difficult for your business to meet its immediate financial obligations.
So, even with an increased profit margin, cash flow problems can arise if the cash isn't coming in at the pace you need to cover your outgoing expenses. This example illustrates why business owners must focus on managing profitability and cash flow effectively.
Strategies to improve and manage your business cash flow
Having unpacked the importance of cash flow and furnished you with the tools to analyze and calculate your business's cash flow effectively, we venture into strategies to improve your company's cash flow and profits.
In the following sections, the magic happens as we reveal actionable tactics to help your business navigate the financial seas with increased confidence and competence.
1. Streamline the billing process
Embracing technology to quicken the invoicing process can significantly improve your cash flow. Investing in the right tech can lead to a smoother billing process, quicker payment settlements, and better tracking of customer accounts. If you're still using a manual system, now's the time to consider moving to digital invoicing.
Another simple strategy is swiftly sending out invoices and conscientiously chasing up payments, which can significantly enhance your cash flow. Also, by setting up a consistent system for collecting payments and prioritizing overdue bills, you can further improve cash coming in.
It would help if you also considered offering perks like discounts for early payments. These incentives can encourage your clients to pay more quickly, speeding up cash inflows and thus improving your business's overall cash flow.
2. Efficient inventory management
Effectively controlling your inventory and aligning it with the demand of your customers is a crucial strategy to improve the cash flow of your business. On the one hand, being overstocked immobilizes your capital, while on the other hand, being understocked can cause you to lose sales. This is where striking a balance is critical.
Consider, for example, a small, independent bookstore. If this bookstore is overstocked, you could end up with numerous unsold books, which take up space and tie up capital that you could use for other purposes. Consistently evaluate what's on your shelves. If you own a restaurant, for instance. Regular checks can help you optimize your menu, using ingredients nearing expiry first to minimize waste and reduce costs.
One method of inventory management that is becoming very popular among small businesses and inventory managers is Just-In-Time (JIT) inventory management. This approach to inventory management ensures that you receive your inventory only when needed, which helps you reduce your costs and keep your customers satisfied. To implement a successful JIT system, you'll need inventory management software to help you monitor your stock levels and accurately predict demand.
If it is something that catches your attention, you can consult with an expert in inventory management. An expert can help you establish the right mix of JIT practices for your specific business needs. In the meantime, you could leverage technology; tools like Quickbooks inventory management software can help you monitor trends in your sales and predict when the time is right to order more inventory.
In the same way, beyond technology, taking advantage of historical sales data, trends in the industry you are in, and in-depth market research can also help you improve your demand forecast.
3. Cut Costs
As you seek to enhance your cash flow, identifying potential cost-cutting measures is essential. The goal is to cut costs without negatively affecting your product or service quality. One helpful and straightforward approach categorizes your expenses into 'bad,' 'good,' and 'best' costs. This classification helps clarify and steer your cost-cutting efforts in the right direction.
Echoing Benjamin Franklin's wisdom, 'Beware of little expenses; a small leak will sink a great ship,' it's crucial to uncover these 'small leaks' in your business. One way to achieve this is by performing a self-audit of your business expenses. Here's how you can approach it:
Find the right time: Conduct your self-audit during a slow period for your business. This way, you can focus without distractions. Remember, plugging cash leaks lets you shift funds from non-productive areas to ones contributing to return on investment (ROI), like marketing or employee retention.
Brainstorm cost reduction: Aim for more than easy cuts. Gather your team and brainstorm ways to improve efficiencies. Ask questions like, 'How would we have managed this cost when we were a start-up?' or 'Is this expense essential?'
Examine cash flow: Review your cash flow to identify trends and potential issues. If expenses increased from last year, find out why. Compare expenses over different periods and look into any upward trends.
Evaluate expense ratios: Measure each expense as a percentage of total revenue. This includes a broad spectrum of costs, from insurance premiums to individual employee spending habits. Pay special attention to expenditures incurred on company credit cards.
Deep-Dive into business expenses: Thoroughly review all business expenses. Pay special attention to areas where businesses often overspend, such as shipping costs, mobile phone usage, and service contracts.
Following these steps will help you uncover valuable insights and potential savings. However, be mindful not to overcut expenses in your cost-cutting pursuit. Doing so could leave your business ill-prepared for surges in demand or susceptible to unexpected costs.
4. Strategize your pricing
Establishing a comprehensive pricing strategy is crucial to managing your cash flow and maximizing your incoming revenue. This strategy should take into consideration the following:
The value your product or service delivers to your customers.
The cost incurred in producing it.
What price the market is prepared to bear.
Periodically revisiting your pricing strategy to ensure its effectiveness is essential. Sometimes, minor price hikes can lead to substantial improvements in cash flow without risking customer satisfaction.
For instance, consider offering a premium version of a product that's already popular in the market. Adding a touch of exclusivity to a well-loved product will refresh its appeal and justify a higher price point. This approach can bolster your cash flow without causing a ripple in your customer base.
For a deeper understanding of setting a pricing strategy that works for your business, you can read: Choosing pricing strategies that grow your business.
5. Negotiate favorable payment terms with suppliers
Optimizing the financial health of your business involves several factors, one of the key ones being the negotiation of payment terms with your suppliers. This process involves more than just securing lower prices. It's about establishing mutually beneficial terms and fostering a robust relationship between you and your suppliers.
Take, for instance, the extension of payment terms. Having a more extended period to pay gives you more room to maneuver financially, allowing you to focus your resources on core business areas such as product development, marketing, and expansion. This improved cash flow can be a significant advantage in running your business efficiently.
Here are some strategies you can utilize to negotiate favorable payment terms with your suppliers:
Assess your bargaining power: To negotiate effectively, you need to understand your standing in the market and the unique value you bring. Examining your financial situation and existing supplier relationships will help you gain leverage in these discussions.
Research your supplier's financial situation: Knowing your supplier's financial health and priorities. Monitor factors like their outstanding debt, cash flow, and profit margins, giving you a strategic advantage in negotiations.
Identify your ideal payment terms: Determine what payment frequency, method, and grace periods work best for your business. Preparing to explain why your preferred terms are beneficial for both parties is vital.
Communicate your needs and intentions: Transparency is crucial when requesting better rates or payment terms. Emphasize the mutual benefits of a new agreement, such as the potential for increased order volume or reduced administrative costs.
Offer incentives and compromises: Creativity can be your ally here. Consider offering early payment discounts for shorter payment terms or volume-based incentives for extended terms. A commitment to a long-term contract or an increased order volume can motivate suppliers to accept your proposed terms.
Understanding and negotiating supplier payment terms is not merely a financial task; it's a strategic move. These favorable terms can also act as a safety net, shielding your business during unforeseen circumstances like economic downturns or natural disasters.
Ready to optimize your cash flow and maximize profits?
The pathway to business success is paved with profitability and effective cash flow management. We hope this article sheds light on the importance of intelligent cash flow control and our practical strategies to help you improve your business cash flow.
Remember, even the most determined entrepreneurs sometimes need an extra push. That's where One Park Financial steps in. One Park Financial has been a reliable partner for over a decade, helping small businesses flourish. We've built strong alliances with leading funders in the industry, enabling us to support small businesses with big dreams. With funding options ranging from $5,000 to $500,000, we ensure that a cash crunch never hampers your momentum.
You can apply if your business has been operating for at least 90 days and generates revenues of $7,500/month. Just fill out our online form.
With One Park Financial as your ally, you're steering your business toward increased profitability and ensuring its stability.
Harness this opportunity and guide your business toward a prosperous future. Remember, you're at the helm, and with the right decisions, the rewards will undoubtedly follow.
Disclaimer: The content of this post has been prepared for informational purposes only. It is not intended to provide and should not be relied on for tax, legal, or accounting advice. Consult with your tax, legal, and accounting advisor before engaging in any transaction.