Although making a profit is the obvious and ultimate aim of every small business owner, cash flow is the 'life blood' of the organization.
It is only by keeping control of the cash in your business that you stand a chance of long-term success. Making a decent profit at the end of the year may feel like success, but a risk of insolvency remains if you cannot pay the bills.
It is so easy to overspend on unnecessary items - some small business owners even put their entire enterprise in danger by spending recklessly. For example, new technology and expensive office rental is not necessary if you can simply work from home with your existing laptop.
As Benjamin Franklin once said, "Beware of little expenses; a small leak will sink a great ship."
What positive cash flow means, and why it is vital to your business
When you are able to efficiently collect money owed by debtors and use it to pay all your monthly bills on time, you have achieved positive cash flow. If there is no money with which to pay bills as they become due, and this happens on a regular basis, you may be in financial trouble.
This can sometimes happen after purchasing a large supply of stock, but when negative cash flow becomes the norm, action needs to be taken to redress the situation.
The best ways to encourage positive cash flow
Putting into place, and strictly adhering to, straightforward systems that deal effectively with late payers, offers a deterrent to customers who think they can get away with deliberately paying their bills late on a regular basis.
Whether cash management and credit control policies are included in your original business plan, or they are currently being introduced, giving structure to your debt collection processes in this way holds many benefits.
Strategies you may want to adopt to enhance your cash flow situation include:
- Setting strict credit limits for your customers, making sure that their credit rating has been checked prior to accepting the initial order. Due diligence should form a large part of your overall credit management policy - credit checks are relatively inexpensive and can save a lot of money and stress in the long-term.
- Setting up a strong credit control system whereby late payments are followed up quickly and consistently. Making your customers aware of the maximum number of days they have to pay in addition to your right to charge interest on any outstanding debt, will convey your determination to be paid on time.
- Not holding too much stock - although stock is a 'liquid' asset, if products have been held for some time it may be difficult to sell them at their full retail value. Buying too much stock uses up valuable working capital and reduces the amount of cash available to run the business.
- It can be tempting to expand the company too quickly if you happen to attract a large order from an established company. This sometimes results in 'overtrading.' Taking on extra staff or renting larger premises to make sure that the order is fulfilled may seem like a good idea, but what happens if that customer runs into financial troubles themselves and cannot pay you? Rapid growth such as this may be unsustainable.
Avoid complacency at all costs
Strong sales, great customer feedback and a healthy cash flow can lead to feelings of complacency. Anything can happen in business, however, and it only takes a little market instability or a competitor's new product to push you off track.
You can only do so much to protect yourself, so what potentially dangerous situations should you look out for, and how can you deal with them?
- Overtrading: the business is growing at a steady rate and you are offered a large contract that will stretch you financially until you get paid. Although very tempting, this situation has been the downfall of many small business owners who do not give enough consideration to their cash position before accepting the contract.
One of the most effective ways to prepare for this possibility is to get into the habit of preparing cash flow forecasts which indicate how much cash is needed in any given month, and how much will be available.
Your bookkeeper or accountant would be able to prepare detailed forecasts if you do not want to tackle this yourself, and you will see in black and white just how much money you are going to need each month.
- A few large customers: although as a sole trader or small business owner it may be tempting to take on a large customer, from a financial point of view it is safer to serve many small customers rather than a few large ones.
Spreading the risk so that no one customer accounts for more than 20% of your turnover means that you are better protected from the financial problems of other businesses.
- Ignoring credit risk: you may have attracted a particularly valuable customer, but on checking their credit file find that they have a history of late payments. Ignoring this credit risk could have serious repercussions.
Being unable to pay your own bills due to late payers is the first sign that the business is in trouble financially, and with the current shortage of available credit for small businesses, the simple act of taking on this customer has the potential to undermine your business success.
As you can see from these examples, you do not need to experience a major setback to find your business financially unstable. It can creep up on you over a period of time, and profit then seems irrelevant as you struggle to make ends meet.
Although profit is the end goal, cash flow needs to be addressed first and foremost in order to stand a chance of running a profitable business.
It is true that without positive cash flow there may be no profit, but good cash flow does not guarantee success. However, teamed with other factors such as great customer service, good decision-making, and some degree of luck, keeping an eye on your cash flow will be an integral part of your business success.
© Zawya BusinessPulse 2014
