Cashflow considerations for small business owners

Written by Roger Jowett, Brainiact Mascot

As a business owner, you’re probably caught up in the day-to-day grind, focusing on generating revenue and keeping customers happy. But here’s the deal. Without solid cash flow management, even the most successful businesses will hit a brick wall. Whether it’s covering everyday expenses or planning for big investments, managing cash flow is the backbone of a healthy business.

Understanding cash flow

Cash flow refers to how money moves in and out of your business. Positive cash flow means you’re making more money than you’re spending, while negative cash flow means you’re spending more than you’re making. Understanding and managing cash flow is crucial because it ensures you have enough liquidity to cover your expenses, invest in growth, and stay afloat in tough times.

The cash conversion cycle

One key part of managing cash flow is having a good cash conversion cycle (CCC). The CCC measures how long it takes for you to turn your investments in inventory and other resources into cash from sales. Simply put, it’s how quickly you can turn your products or services into cash.

Having a good CCC means your money isn’t tied up for too long, whether it’s a few days or weeks. But if your cycle drags on, with money stuck in materials, parts, or labour and you’ve not been able to invoice or get paid for up to three months, your cash is tied up for up to 90 days. This can strain your finances and you won’t be able to operate effectively!

Inventory management

Good cash flow starts with smart inventory management, especially if your business deals with physical products. It’s all about balance. Too much inventory means your money is stuck in things just sitting on the shelves. Too little inventory, and you might miss out on sales or upset customers. Regularly check how fast your stock sells and adjust your orders to keep stock moving.

When you buy stock or materials, you often pay for them upfront, but it can take weeks or even months to get paid by your customers. Your money is tied up until your customers pay you, which can take up to 30 days or more. High-margin items can handle this better, but if you’re selling low-margin items, it can get tight. Keep your inventory turning over quickly.

For service businesses like plumbing, you need enough materials on hand to do your job, but buying as you go can be more efficient. Once you’re more established, try to get credit terms with your suppliers so you can buy on credit, complete the job, invoice your customer, and get paid before you have to pay your supplier. This helps keep your cash flow strong by essentially using your supplier’s money to operate. It’s a smart move.

Consider a Just-In-Time (JIT) inventory system, where you order goods only when needed. This reduces storage costs and frees up cash that would otherwise be stuck in unsold stock.

Supplier and customer terms

The deals you make with your suppliers and customers have a big impact on your cash flow. When dealing with suppliers, try to get longer payment terms. If you can secure 60-day payment terms instead of 30, you’ll have more time to convert inventory into sales and cash before having to pay for it. Negotiate hard but stick to what you agreed. If you pay on time, suppliers will see you as a reliable partner and you can build a relationship that’s advantageous to you.

At the same time, when you’re dealing with customers, try to get shorter payment terms so the cash can keep flowing into your business. Send out invoices as soon as possible. The sooner you invoice, the sooner you get paid. Make sure your customers know when they need to pay. Clear terms help avoid misunderstandings and ensure you get your money on time.

Collecting invoices promptly

If you’re not generating invoices, it’s like not putting oxygen in your lungs! Here’s how to get paid on time so your cash flow stays healthy.

Make a habit of invoicing regularly. A lot of my business coaching clients tend to invoice at the end of the month, but it’s better to invoice every day or week. This way, you won’t forget any details, and your customers get their bills faster. If you’re trying to raise an invoice for something you did 29 days ago, you might miss a few bits and pieces. The sooner you invoice, the better.

There’s also a psychological aspect to timely invoicing. If you invoice someone right after providing a service, they are more likely to pay quickly. They have the invoice fresh in their minds, and you’re giving them a chance to address any questions immediately, which means fewer delays.

Always make sure your invoices are accurate and detailed. The last thing you want is for a customer to be confused about why they’re being charged or feel like something’s missing. This can lead to disputes and delays in payment. Double-check your invoices to prevent these issues.

Efficient collections

You need to be getting paid on time. I’ve worked with a lot of small businesses that simply don’t look at or care about who’s paying them on time and who’s always late, and that’s their downfall.

Use a receivables ledger to track who owes you money and regularly check this list. Xero, for example, gives an automated report that shows what you’ve invoiced in the current period and what invoices are 30, 60, or even 90 days overdue. Aim for a clean ledger: It should be a nice big number in the ‘Current’ column, a few in the ‘30 days’ column, even less in the ‘60 days’ column, and almost none in the ‘90 days’ column. A clean ledger means you’re getting paid on time, which is worth celebrating!

Set clear payment terms and good behaviours with new customers from the get-go. If you expect payment in 30 days, remind customers around day 25. If they haven’t paid by day 31, follow up immediately. It might feel uncomfortable, but it’s necessary to keep your cash flow healthy. Sometimes a simple reminder is all it takes. Set up a process for sending reminder emails and making phone calls.

The most common mistake is not cleaning up the receivables ledger. If you have a job from two years ago that’s still unpaid, it’s time to write it off. Talk to your accountant about how to do this properly so your records stay clean. Sometimes you have to accept that an invoice won’t be paid and take the hit.

Work out which customers you want to keep—those who pay you on time and are good to work with. For difficult customers, you want to end it amicably, so instead of cutting them off, just distance yourself. You can do this by quoting higher prices or indicating longer wait times for new work.

Managing expenses

Keeping a close eye on your expenses is just as important as managing your income. Understanding the difference between fixed and variable costs can help a lot with planning and budgeting. Fixed costs, like rent and salaries, stay the same no matter how well your business is doing. Variable costs fluctuate with sales.

Regularly review your expenses to see where you can cut costs without compromising on quality or efficiency. Look for areas where you might be spending more than necessary. A few small changes can make a big difference to your bottom line.

Forecasting cash flow

From what I’ve seen, business owners simply don’t forecast their cash flow. It’s a big mistake. You need to think far ahead, or you’ll find yourself saying, “Wow, I owe $100,000 in taxes and don’t have the reserves.” If there are two sure things in life, it’s death and taxes, right? You need to be prepared to pay them.

A simple strategy is to set aside a portion of your revenue each month for taxes. For instance,  if your business makes $50,000 to $60,000 a month, put the GST portion in a separate account. Setting aside about 10% of your revenue monthly ensures you’re ready when the quarterly tax bill arrives. Treat it like a non-negotiable expense, just like rent or salaries.

But forecasting isn’t just about taxes. Many businesses face large, occasional expenses for things like machinery or equipment. If you have machinery that lasts three or four years, you need to plan for its replacement. This applies to other big-ticket items like vehicles or computers. Even if you lease these items, knowing when these expenses will occur helps you plan your cash flow.

For short-term forecasting, make weekly or monthly cash flow forecasts to stay on top of your daily finances and catch problems early. For long-term forecasting, create quarterly or yearly forecasts to plan for big expenses and investments, make smart decisions, and ensure you have enough cash to grow your business, helping you avoid any financial surprises.

Effective cash flow management will position your business for growth and success. By understanding your cash conversion cycle, managing inventory and receivables efficiently, and forecasting cash flow, you can make sure your business stays healthy and thriving.