Small Business Cashflow...How to Avoid The Negative and Develop The Positive

Without Proper Control Over Cashflow Your Business Could Go Under In As Little As Two Years!

Managing your cashflow means managing your sales and receivables (cash flowing in), managing your spending (cash flowing out), managing your credit.  In other words...managing your business!

Businesswoman under a pile of papers

You've heard it. I've heard it. We've all heard it. Cash is KING! - well at least in the normal day to day small business world. Negative cash flow is bad. Positive cash flow is good. To even the untrained man on the street that last statement makes perfect sense.

Negative cashflow means you have more cash leaving your business then what you have coming in. Negative cash flow is a disease that drains the life blood (cash) out of your business.  Positive cash flow is a product of the application of good and consistent small   business management practices.  The right small business management practices can stop that negative flow and turn it around. But business management doesn't just happen, and neither does positive cash flow.  You have to make it happen. But what IS positive cash flow? In order to find out what it is, we have to first see what it isn't.

Being Close to Your Business In All The Wrong Ways.

Having owned several businesses myself, and having worked with many businesses in the area of bookkeeping and accounting, I noticed that small business owners sometimes become so excited about owning a business that they forget they have to “manage” their business. They are so excited about working “in” their business, they forget they have to work “on” their business. They think so much about production, that they forget about the other two umbrella elements of their business marketing and accounting. When a business owner can successfully work these three areas so that they overlap in the middle, not only will their cash flow be positive, but they will have discovered the secret to profits. [2]

Unfortunately, when some small business owners finally do start to realize that there is more to running their business then waiting on the customers (production-producing sales), they have a tendency to think and act on what they call “gut instincts” and trial and error, instead of looking toward their accounting/bookkeeping for answers.

Then it happens... the unthinkable. The business doesn't have enough money to pay all the bills. It starts as just one month here or there. Maybe at first they stop paying one or more local merchants so there is enough money in the checking account to pay their payroll and payroll taxes. Soon the local merchant calls and reminds the small business owner how they went out on a limb to give them credit. They expect their bill to be paid and paid on time. So the next cash that comes in goes to pay oil the local squeaky wheel, the local merchant.

In another month, the small business owner decides to keep paying the merchant regularly, but in order to do that they have to tell their own employees that they will have to wait to be paid. The employees are furious and threaten to go to the Attorney General's Office and the Department of Labor and anyone and everyone else who might help them to get their money, and possibly put you out of busness.  The small business owner knows the employees are right and so as soon as possible the employees get paid. Now however, something else has to be sacrificed like pawns in a seemingly never ending game of chess.

So in order to pay the payroll, the small business owner decides NOT to pay the payroll taxes.  Seems to happen every time.   This gives the business owner a false sense of security, comfort, control and relief since the IRS is far away and at best, they will just send notices. They rationalie that it's ok.  So they'll have to pay a little bit of money in fines and interest.  That's just another form of "credit".  No big deal.  At least they won't be on the doorstep like the merchants and employees demanding their money. And soon the IRS notices start to pile up. And so do the penalties and interest charges from the IRS.[1]  But the small business owner is so sure that any day now things will look up, and they will be able to pay the payroll taxes and get everything caught up again.  But the fact is, that this business is probably on its way out and the next step may be bankruptcy.

The above is an all too familiar set of circumstances for far too many business. Good people with good intentions becoming snowed, under a pile of papers and cash flow problems and little to no thought as to which direction to turn for specific answers. They have no knowledge or experience as to how to recognize the signs and symptoms of poor or negative cash flow and poor management practices. Most small business owners don't know they even have a problem. Some small business owners believe that as long as there is money in the checking account, their business must be doing fine. If they do start to feel something is wrong, they don't always know what or know how to solve it, or even know the questions to ask to find the answers. And most of all, they don't know that the answers are right there in their own recordkeeping and bookkeeping systems. Without knowing to work “on” their business, by managing, not just production, but also marketing and accounting, they can't see “trends” or hear the “alarms” being sounded by these trends in time to take some positive measures to both PREVENT negative cash flow, and ultimately establish a regular positive cash flow.

But what are these measures you ask? What are the real nuts and bolts to begin preventing or turning negative cash flow to positive? Such measures might include loans from lending institutions, friends, neighbors or family. Maybe taking on a partner. Other measures to take before considering loans is also discussed a little later in this article.

Small Business Owners Love Their Business.

It is their dream come true. In many ways, it is a genuinely freeing experience to own a business. They control their destiny. Well at least they control that which is within their control. Small business owners sometimes even assign human traits and terms of endearment to their business such as calling it their “baby”, their “wife”, their “marriage”. If this sounds like you, you first need to resign yourself to the fact that your business is a set of cold, hard, calculated facts represented by numbers with only four distinct purposes: 1) fill a need or a want of the consumer; 2) produce a sales income from having filled that need or want; 3) pay the bills it accumulates doing #1 and 2; 4) eventually produce a profit after #3.

Your business does not have a heart or feelings or gut instincts. And thus does not run on feelings or gut instincts. It also doesn't manage itself or run simply on good intentions. It is ok for you to have a dream and work to make it come true, but understand that you must:

  • consistently work “managing” your business.

  • look at the information about your business found in the collection of data organized inside your bookkeeping system.

  • use the information in your financial statements produced by your bookkeeping system, to be “proactive”.

  • set goals for your business.

  • make decisions based on that information to make your business reach its goals.

  • make decisions to help you control your cash flow and to achieve positive cash flow.

  • learn to project your cash flow. [3]

 Now that we know what cash flow ISN'T, we can begin to see what it IS.

Cash Flow Is The Life's Blood of Your Business.

Cash flow is the foundation upon which the business is built. It is the survival mechanism by which it functions day to day. Just like children need well balanced meals including carbs, protein, fat, vitamins, and minerals in just the right amounts and combination to grow, a small business need cash flow achieved and sustained by applying the right small business management practice in order for that business to not just survive, but to thrive and grow. Watching the financial pictures of your business such as your balance sheet, income statement and statement of cash flows, you can see problems coming long before they happen.

Look at your statement of cash flows. Study your “cash in and cash out” over at least the past three months, but over a year is even better. You want to get a good idea of your operating cycles. When do you make the most credit sales? How well defined and managed are your collection processes? When do you buy the most on credit? When do you spend the most money in operating costs? You can spreadsheet it. I think the best way to actually see it is with a chart. Any chart will do. A pie chart. A line chart.  A bar chart.


Per Year Cash Flow ChartCredit: The PlanMagic BnB 12 Financial Plan Charts

Chart the year to year and month to month total of all cash in against all cash out. What you want to look for are the times when your cash in and cash out are out of whack. When there is too much or too little of one or the other. The first objective is to have both of them occur as evenly as possible over the course of the year. For example, if cash outs are around $50,000 per month, then cash ins should be around $50,000 per month. And vice versa. More cash in is always better than more cash out, but if that isn't possible then at least an even flow of each is best. “How do I go about doing that?”, you may ask. Well, if cash flow is the life blood of your business, then negative cash flow means your business is bleeding and you have to control and stop that bleeding through good management practices.

1.  Manage Accounts Receivables.  

For many, this is the bread and butter of their business.  For instance, new car dealerships don't make their money off of selling new cars.  They make their money off the "loans" from selling new cars.  People who OWE money.  Accounts Receivables.  But only if it is managed and managed properly.

Before you start granting credit, make sure you have thoroughly researched, developed and communicated your business' credit policies and procedures. Make sure the necessary employees and all customers are well educated on your policies starting with how and to whom credit will be granted and continuing all the way through to what happens when a customer misses their first payment by 30 days, 60 days, 90 days and 120 days. Each one of these time periods should trigger another procedure. Maybe at 30 it's an “oops you forgot your payment” notice. At 60 it's a “Second Reminder. Please pay now” notice. At 90 days it could be a phone call to find out what's wrong, "we want to keep you as a customer, can we make alternative arrangements”, etc. type call. At this point, especially if this is a repeat customer, you want to keep their business, but you want to be paid at least something now.  Negotiate, try to get at least two thirds now and make separate arrangements for the rest.  Selling the debt, even if it is recovered, could bring you pennies to nothing.  Then at 120, you might want to send a certified letter explaining that unless you are paid by a certain date, you will be taking certain legal action. You may even want to send this notice at 90 days and at 120 days actually have your attorney send a notice. You can even have your attorney write a letter or a series of letters that become more and more stern.  At some point you may want to see what is left to a collection agency and/or write off the debt.  If you can't collect the money, the only way you can use it as a tax writeoff is if the money was previously counted as income, or if you are operating on a "cash basis".  NOTE:  Seek advice from a tax accountant before deciding which accounting basis you will use accrual or cash.  Do NOT change the accounting basis on which you operate.

Also, in these policies and procedures be sure to include how you will handle insufficient funds checks if you plan on accepting checks as payments.  Again, attorney letter will be helpful here as a last resort.

2.  Manage Accounts Payables

One way to hold on to your money for as long as possible is to manage your accounts payables. Pay them on time, not early, unless there is a discount, and never late.

  • Talk with your vendors to make the payments on your accounts payable more even throughout the year.

  • Avoid high bills one month and no bills another.

  • Take advantage of early discounts. If your vendor doesn't offer them, negotiate for them.

  • If you cannot negotiate a discount for early payment, then pay on time. This means use electronic funds transfer as often as possible and pay either the exact day or the day before, but no sooner.

  • Avoid paying late fees and finance charges by paying bills on time, not early (if no discount), but not late either – on time![4]

3.  Manage Credit.  

When you first start your business, you should expect to invest at least 50% of the capital needed to start and run the company. You should have a startup plan that includes how much is needed to start your business and how much is needed to run your business until your business can produce enough money to pay its own debts.  While it is advisable to obtain a credit card for your business, you must know how to manage this and other credit. The investment of money up front into your business lessens the amount of cash needed from other costly sources such as credit.

At first, it may be difficult to obtain trade credit. Just like a young adult starts out in life and often has difficulty obtaining credit, it could be difficult for your business to get credit, if it has never had credit. Vendors may require you to use your personal credit. Be careful. You may not want to personally guarantee the payments of your business. If a vendor is requiring this, you may want to find another vendor who will not. Personally guaranteed credit is just that. If your business goes under, and even if it is an LLC, you could possibly still be held liable for business debt. 

During this startup time, you can also expect to receive less than favorable credit terms. You may be expected to pay cash or at least pay within 30 days. Once you have had a 30 day payable, say about 6 months to a year, and kept it paid in a timely manner, work with your vendors to try to extend the credit terms to 60 or even 90 days. You will find most vendors will negotiate once you establish yourself as a good customer. They will not want to lose you. Remember to work with all past, current and future vendors to establish and move from 30 to 60 to 90 days whatever is necessary and whenever possible in order to align your “cash out” numbers with your “cash in” numbers.

Only use your credit card to EXTEND your cash flow for one month. This means, for example, if you have bills for which you can pay, you can KEEP that money in the bank for another 30 days by using your credit card. Once again, this is used to help match your “cash in” and your “cash out” numbers, not to pay for items for which you do not currently have money.

 Match carefully your recurring bills and your expected accounts receivables for the upcoming months. This will help you see a possible cash flow problems in the next couple of months. 

Other Areas That Influence Your Cash Flow:

Spending.  No one LIKES to live within a budget, not even you in managing your business. But that is exactly what you must do! You need to establish a budget for your business and figure out how to work within that budget. If you have at least one year of history doing business, one year of transactions, use that year as the basis for a budget for the next year. If you are just starting out, one of the things you should have determined was your starting and working capital. If so, just start plugging it into the holes you originally meant for it to fill. Starting capital sustains your business until it starts producing an income. Working capital is used to cover the expenses of the business and its short-term debt which we will talk about in a minute. 

If you didn't determine your starting and working capital, then you need to do it now. If you don't pay attention to numbers and money needs right now, you may be facing a rough road ahead. Money in the bank can't just be spent because it is there.  Some call this the reactive way. You, in your business, are “reacting” to threats and opportunity. You should be making “proactive” decisions about your business and your spending inside that business. Meaning you have to look for and plan for as many threats and opportunities as possible in order to be able to control cash flow and have enough money as you encounter those planned for threats and opportunities.

For example: a restaurant is housed inside the clubhouse of an HOA. The HOA is planning to close the clubhouse, though not the restaurant, for some major repairs. Ultimately, the restaurants customers will misunderstand the advertising closure thinking the restaurant will be closed. Or maybe they just don't want to have to walk through the repairs in order to go to the restaurant. But for whatever reason this will negatively affect the restaurant. This is a threat to the “numbers” of the restaurant. The restaurant knows this because it has happened before and when they read the “numbers” in their financial reports it showed that the restaurant took a heavy loss in sales income the last time.

Being “proactive” by consistently watching their numbers, and knowing far enough in advance of this new clubhouse closure, allows the restaurant management to again be “proactive” by planning a special function to happen before th repairs which results in additional sales income that is counted in their current month and continues to keep their cash flows in check and positive. This additional sales income now makes up for the loss of sales income they know they will experience during the clubhouse closure. This means they won't see an unexpected dip in their “cash in”. They won't be left with not enough cash to meet their expenses.

Money in the bank.  You need to hold on to this valuable asset while at the same time making it work properly with the business' other assets to produce more income.

Unnecessary Bank Fees.  Eliminate them.  Shop for a bank. There are still banks or credit unions that have FREE or low minimum balances for small business. Make sure you read and understand the fees that banks and credit unions assess. Types of fees include: overdraft fees, returned check fees, failure to maintain minimum balances fees, too many items in and out of your account fees, bank analysis fee, account management fee. These are some of the more common fees. Educate yourself. Too often a business owner thinks they make too much money to worry about such trivial fees. But over time those trivial fees can represent a significant loss of deposited funds.

Separate Business and Personal Checking Accounts.  If you have not yet done so, then you want to immediately establish a separate bank account for your business so that the financials of your business are not mingling with your personal financials. Even if your business is small, you want to do this. It is too easy to spend money that belongs to the business for personal reasons, when that money is meant to be spent on the business' debt. Besides this being required by the IRS, you are likely to miss out on valuable expense deductions, not to mention your books will be an absolute nightmare for your bookkeeper.

Set Up Two Business Accounts-One for Operating Expense, One for Payroll and Payroll Taxes.

This is an area that can get a business in trouble fast as I noted earlier in this article.  Make sure you have money for your payroll and payroll taxes by opening up a separate bank account.  It is too easy for an owner or manager to just check the checkbook and blanketly ok some other expenditure and wipe out any and all monies set aside to take care of your payroll obligations.  Don't let it happen in to you.

Cash is KING, but negative cash flow is the disease draining the blood (cash) from your business. Work “on” your business, not just "in" it. Stop negative cash flow, and turn it into positive cash flow by being “proactive” and applying good, consistent, small business management practices. Turn your dream into a thriving reality once again!