How to Manage Cash Flow as a New Business

Cash flow is the top reason why so many new businesses and startups fail in their first year.  Without adequate money going into a company for operations and management, it becomes impossible to turn a profit.

Not only is running a business without consistent cash flow risky for its longevity, but it can also make it feel stressful and uncertain for those operating it. As a result, learning how to manage cash flow is the only way to ensure the long-term wellbeing of your business through sustainable business practices.

What is cash flow?

When you are running a business, you are in a continuous cycle of spending and making money. Cash flow refers to the amount of money that is moving in and out of your business in a given period.

Cash flow can be positive or negative. A business that has positive cash flow has more money coming in than going out. For example, every time a restaurant owner gets paid for a catering event, it adds to the business’ revenue, contributing to positive cash flow.

However, every time the business owner places an order for takeout containers and utensils, the money spent on the order contributes to negative cash flow. This is why a business that has more money going out than it does coming in is said to have negative cash flow.

Every time an operational or a sales decision is made, it affects the cash flow of a business.

The 3 categories of cash flow: Operating, Investing, and Financial

In addition to being positive or negative, cash flow can be broken down into three categories:

1. Operating cash flow

This type of cash flow refers to the net amount of money generated from a business’ day-to-day operations.

2. Investing cash flow

This type of cash flow refers to the net amount of money generated by a company’s investing activities, like physical property or various assets.

3. Financing cash flow

This type of cash flow refers to how the money is circulated in a company within its stakeholders, like owners and investors, and may include debt, equity, and dividend payments.

How is cash flow different from profit?

While cash flow represents the total amount of money moving in and out of your business, a profit refers to the remaining balance after operating costs are subtracted from your business’ revenue. Looking at the profit line of a business can provide a general overview of its performance. In contracts, cash flow can provide insights into the business’s ability to meet daily and future expenses.

Much like cash flow, profit can be a positive or a negative number. If the profit is a negative number, it becomes a loss, because it indicates that the expenditures are too high for a profit to be made from the interaction. Companies with too many instances of loss risk negative profitability evaluations when applying for funding and grants.

What causes cash flow problems

While every business is different, two-thirds of business owners say that delays in payment are the largest contributing factor. When your customers make their payments late, it decreases the float of money your business has to pull from for everything from day-to-day expenses, to longer-term investments like additional locations, equipment, or software. This can result in a position where the business’ expenses exceed the amount of money coming in, resulting in a cash flow problem.

Of course, inadequate financial planning is another reason why a business may end up with cash flow issues. When business owners fail to regularly review their monthly financial statements and revenue projections, they can find themselves strapped for cash to keep the business afloat. That’s why it’s important to keep every expense in record such as bill payments, invoices from clients, your employee’s expenses for business use, etc. If you want to easily do employee business expense reimbursements, you can look for software with this feature.

What types of businesses are most affected by cash flow problems?

Certain types of businesses are more susceptible to cash flow issues than others by their nature. The three most common types of businesses to face these challenges are:

Small businesses cash flow

Small businesses are highly likely to face cash flow problems. In fact, it is such a widespread issue that cash flow is said to be the reason as many as 82% of small businesses fail.

For small businesses, there can be fewer safety nets than large, integrated businesses. This means that sudden business needs like repairs and external forces like spikes in supply prices can put pressure on a business’ profit margins, affecting cash flow.

New business and startup cash flow

New businesses and startups are also more vulnerable to cash flow issues for similar reasons. When a business is getting off the ground, it requires upfront expenses and the payment of overhead costs. This makes it difficult to maintain a cash reserve for sudden expenses, which can swing a business’ cash flow into the negative. Cash flow presents a special challenge for new businesses because there is often no cash reserve to dip into when the expected happens.

For startups, there is an added layer of complexity because with this business model, securing funding is what gives the business temporary financial security until the business becomes financially sustainable. Startups usually require large sums of cash for research and development expenses that are not attainable for a new business. As a result, startups compete for financial grants that help them get their products and service models business-ready.

However, financial training is not always provided in tandem with the grants, which can lead to cash flow problems if the business decision-makers take risks without a firm understanding of what is achievable within the limits of their cash flow.

Seasonal businesses and cash flow

Another type of business that is more likely to face cash flow issues is a seasonal business. Examples of seasonal businesses include landscaping, tutors, tour guides and pet sitters. All of these businesses face an annual customer “drought,” where demand for their business takes a sharp dip.

As a result, these businesses sometimes struggle with rationing out their profits and cash reserves to account for the low-income season. For businesses like these, building up a customer base can be a yearly undertaking as customers may lose loyalty to the business after not using their services for part of the year, contributing to cash flow issues.

3 tips for managing cash flow for businesses

While running your own business can come with its own challenges, it is also incredibly rewarding to be your own boss. Responsible business owners have the power to take steps to better manage their cash flow to minimize cash storages and healthy financial performance.

Here are three steps business owners can take to prevent running into cash flow problems:

1. Benchmark your business performance

You should aim to perform a cash flow analysis at least once a month. For businesses that involve more frequent spendings and invoicing, a weekly performance evaluation is best for keeping track of cash flow. Performing cash flow analysis helps you get a sense of the financial ebbs and flows of your business and give you a sense of a benchmark where you tend to net out on average.

To perform a cash flow analysis, determine the amount of cash you have at the start of the evaluation period. Next, enter your expenses and payments into an outflow and an inflow column, subtracting and adding each from your starting sum of cash. If you arrive at a positive number at the end of your calculations, this indicates your business has a positive cash flow. A negative number indicates a negative cash flow.

2. Maintain a cash reserve

Every business is likely to face a financial challenge at some point in its life cycle. Whether it’s an unmissable investment opportunity or a major repair that’s behind it, businesses should prepare for this day by maintaining a cash reserve they can dip into.

When it comes to the question of how large a cash reserve should be, the answer varies on the industry and overall health of your business, so speaking to your financial advisor is the best option to find the number that works for your business’ needs. However, most Certified Public Accountants (CPAs) suggest that 3-6 months’ worth of expenses is an adequate amount to prepare businesses for uncertain challenges.

3. Stay vigilant about payables collection

When possible, mark invoices payable immediately and shorten your payment terms to no longer than 14 days. This keeps outstanding payments fresh in your customers’ minds. At the two week mark, always contact delinquent payment holders to send them a message that you expect payments to be on time, and to set the expectation for future invoices. Stay consistent about reaching out to customers every time a payment is late to set the tone for your business relationship.

In addition, you can incentivize early payments to encourage your customers to pay ahead of time to give yourself more of a cash pool in periods where you expect your business expenses to be higher.

Cash flow is imperative to the overall success of your business

Proper management of cash flow is essential to the survival and overall success of your business. While certain businesses are more susceptible to cash flow problems, there are steps you can take to prevent and address them before they limit your business’ short and long term potential. By making cash flow your friend, you can worry less about money and focus on growing your business.

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