Are you trying to manage your cash flow better? Under ordinary circumstances, effective cash flow management means your business is investing in its future, is prepared for emergencies, and can cover its current expenses. An economic crisis is a game-changer, though.
In difficult economic times, managing your cash flow effectively can not only ensure you weather the economic crisis but come out stronger than your competitors. The steps you need to take to shore up your cash flow strategy are different too.
On this page, we'll explore what cash flow means to your business, how it differs from other financial measures of success, and how to manage it more effectively in an uncertain economy.
Cash Flow vs. Revenue vs. Profit
Before we dig into managing your cash flow, let's take a quick look at how cash flow, revenue, and profit differ.
The net cash moving in and out of your business is your cash flow. It's a measurement of the liquidity of your business. A simplified equation to calculate cash flow is:
Cash Inflows - Cash Outflows = Cash Flow
For example, let's say one of your customers pays a $10,000 invoice this week, and you don't pay any bills. Your calculation would be $10,000 - $0 = $10,000. You'd have $10,000 positive cash flow!
That sounds good on paper, but maybe your monthly snapshot only includes that single payment, and you spent $6,000 on labor, $2,000 on rent, and $4,000 on operating expenses. Your calculation would be $10,000 - $12,000 = -$2,000. You'd have -$2,000 cash flow. You're in a tough spot for the coming month, and you're not in a position to handle emergencies.
The money your business earns through the sale of products or services is revenue. It's usually a measure of how well your sales and marketing are working. An example of a simple revenue equation:
Cost Per Unit x Number of Sales = Revenue
So, let's say your business charges $100 per unit (be it a product or service), and you sold 20 units this week. Your calculation would be $100 x 20 = $2,000. Your weekly revenue is $2,000. Note how the calculation doesn't include any of your expenses, nor does it indicate whether you actually collected on any of those sales. It's only the money you've earned.
The money you have left after paying expenses is your profit. Gross profit is calculated with the following equation:
Revenue - Cost of Goods Sold = Gross Profit
Let's break this down too. We'll use the revenue generated from the last example. Your business generated $2,000 in revenue last week selling t-shirts, and you spent $500 on materials and payroll. Your calculation is $2,000 - $500 = $1,500. Your business generated $1,500 in gross profit last week.
As you know, however, there's more involved in creating those shirts than the raw materials. You have other fixed and variable costs, such as a facility to pay for and marketing. That's where net profit comes in. The formula is as follows:
Gross Profit - Operating Expenses = Net Profit
So, maybe your gross profit was $1,500, but you spent $1,000 on rent and another $250 on other operating expenses. Your calculation is $1,500 - $1,250 = $250. Your net profit was $250 last week.
Looking at Cash Flow, Revenue, and Profit Together
While cash flow, revenue, and profit can be used to gauge the health and financial success of your business, each one refers to something different. Your business could experience a cash flow crisis and still rake in revenue and generate profit. You might even have great cash flow but not be profitable. The variations are seemingly endless.
Cash Flow Management Defined
So, if cash flow is the amount of money moving in and out of your business, many things can impact it. For example, you may get a cash flow influx by taking out a loan or collecting from a sale, but your liquidity reduces when you write paychecks or pay your rent.
You need a certain amount of liquidity to ensure you can cover all your ordinary expenses and emergencies, but if your business is "too liquid," it signifies you might not be investing in growth. That can stall your business. Many small businesses, startups, and growing companies have limited cash flow for this reason.
With that in mind, cash flow management relates to ensuring you're taking the necessary steps to ensure your business has the liquidity required to cover expenses and handle emergencies. You should be looking at cash flow over a specific period, such as weekly, monthly, or quarterly.
If, for example, your business brought in $50,000 last month but spent $60,000, your cash flow is negative. That might be normal and expected if you've been saving and had a one-time equipment spend of $20,000. However, you generally want to strive for consistently positive cash flow aside from extenuating circumstances such as this.
That's what makes challenging economic times so difficult for small and growing companies. It only takes a few late payments (or even one big late payment) from customers to diminish cash flow to the point it's impossible to keep up with your expenses. This is exactly what was seen with the pandemic. Late B2B payments surged by 25 percent per Atradius. Payments more than 90 days overdue doubled as well. Even if a business maintains the same revenue and profitability level, cash flow struggles can still mount because of late payments.
9 Cash Flow Management Tips for Uncertain Times
When the economy is strong, cash flow optimization strategies often surround growth-minded activities. For example, making sure you're not giving yourself too much of a buffer and failing to invest in growth. In difficult times, or if your business is experiencing a cash flow crisis, you'll want to do what you can to increase or speed up inflows while decreasing and slowing outflows. The nine tips outlined below focus on these areas.
1. Slow down payments.
You'll keep money in your pocket longer by processing payables slower. Explore the terms you have with vendors to identify which of your bills are good candidates for this approach. Naturally, you'll want to avoid picking up any late fees or penalties. However, you'll also want to consider the business relationship you have with each to ensure a sluggish payment isn't going to damage their willingness to work with you, offer good terms, or jump to action when you need something.
2. Put a freeze on non-essential spending.
Your operations may already be lean but take a hard look at each expense you're covering and anything you plan to purchase. You may find that you can hold off on procuring inventory or office supplies to minimize expenses. You may also be able to place a moratorium on things like employee perks as well. Just be sure to address the situation in a sensitive way and let the team know when you plan to bring perks back.
If your business needs to invest in equipment, consider leasing it rather than outright purchasing it. Leasing may be a bit more expensive in the long run, but spacing out the payments will help your business get through the crunch today.
3. Increase prices.
See if there's room to boost prices to increase cash flow. Suppose you're in the service industry and have concerns over how a rate hike will impact relationships. In that case, you can consider alternatives such as only increasing rates for new customers or explore ways to increase value along with costs.
4. Adjust payment terms.
The wait for payment on an invoice can be grueling, especially in tough economic times when many companies pay past the due date. If you're currently offering Net 60 or Net 90 payment terms, consider dropping it down to Net 30.
If you're already doing Net 30 and still aren't getting payments fast enough, you may be able to reduce to Net 15, offer a discount for early payment, or add a fee for late payment to give your accounts receivable a boost. Cash-on-delivery or requiring pre-payment are viable options for many businesses too.
5. Reduce inventory.
Do you have cash tied up in unused inventory? It may be time to liquidate some or all of it. Just be sure to crunch the numbers to ensure the cash flow injection you receive is worth any hit you might take for selling inventory for less than you paid.
6. Explore financing options.
Banks tend to reduce lending when the economy takes a hit. COVID-19, for example, caused a 50 percent reduction in loan approvals per the Small Business Lending Index. That makes it difficult to obtain traditional loans and lines of credit. However, you still have options.
One alternative is invoice factoring. Rather than taking out a business loan and paying interest, you can sell your B2B invoices to a third party known as a factoring company. The factoring company pays you most of the invoice's value right away and then waits for payment from your customer.
7. Establish credit with lenders and vendors.
As reported by the Washington Post, the lion's share of Small Business Association (SBA) Paycheck Protection Program (PPP) loans went to large companies during the early days of COVID. Small businesses were often left out because they weren't established with lenders, and banks prioritized their existing customers when everyone rushed to apply. With that in mind, it's better to establish credit before an economic or cash flow crisis emerges. However, ongoing relationships with lenders will still benefit your business in the long run, so it's a good idea to get connected at any point.
Many vendors also offer credit, though it's not always marketed as such. Find out which of your current suppliers allow you to make payments or pay slowly. If not, find out if any of their competitors do. You may get a better deal by switching or be able to use the information you gather to encourage your current vendors to adjust their policies.
It's also worth noting that effective cash management paves the way for both these strategies. If you have a good payment history and know exactly when you can pay your balance off, you'll go into negotiations with more leverage.
8. Identify short-term strategies to boost sales.
Many small-business owners stop marketing as part of freezing their non-essential spending. This approach can be damaging to sales now and hurt your business in the long run because it prevents you from growing at a time when sales may already be dwindling.
Rather than stopping your marketing efforts altogether, find out if there are more cost-effective methods to get your message out. Then, choose promotions that speak to the concerns your customers have today. Because they are likely dealing with many of the same issues you are, discounts and coupons are good areas to explore.
9. Monitor cash flow.
Don't settle for knowing where your cash flow sits today. Be proactive and create a cash flow forecast. That way, you'll know in advance if any period will be especially tight and take corrective action ahead of time. This can be done weekly, monthly, or quarterly by examining all major cash inflows and outflows.
For example, if you can pinpoint that you'll have a shortfall next month around the time your rent is due, you can ask your landlord for a grace period or put off purchasing supplies. Suppose you recognize that you'll need to order supplies a couple of weeks before your clients are expected to pay their invoices. In that case, you can accelerate cash flow through factoring, contact clients with overdue balances, or run a promotion to try to boost sales.
Improve Your Cash Flow with Factoring
If accelerating payments on your B2B invoices sounds like the ideal way to improve your cash flow, Viva can help. With fast advances, low rates, and a streamlined approval process, our factoring services help businesses of all types weather difficult economic times and grow. To get started, request a complimentary quote.