Cash flow management for small business owners
“Cash flow management is the key indicator of success and sustainability for small business owners. Poor cash flow management can lead to missed opportunities to invest in business growth and inability to pay expenses, which could result in going out of business. ”
To properly serve my small business owner clients, I address several financial planning items thoroughly as all of them work together in a client’s financial life. Comprehensive financial and tax planning for small business owners provides immense value as there are so many exciting items to address with my clients that will have a positive impact on their financial lives. However, the primary topic to address is cash flow management, which is the first building block of any successful financial plan. Knowing where money is being spent and the capacity to save (i.e., income less expenses) is what provides a solid foundation for small business owners. Cash flow management is the key indicator of success and sustainability for small business owners. Poor cash flow management can lead to missed opportunities to invest in business growth and inability to pay expenses, which could result in going out of business. I note three cash flow management strategies for small business owners that can improve their financial health: Monitor cash flow regularly, Maintain a strong liquidity position, Diversify streams of income.
Monitor cash flow regularly
Small business owners should regularly monitor their cash flow as it allows them to address potential issues before they become significant problems (e.g., cash shortage). Small business owners could experience fluctuating income due to changes in the economy and/or unexpected expenses. With regular cash flow monitoring, small business owners can anticipate potential cash flow shortfalls and take the appropriate action (e.g., adjust expenses, adjust cash flow forecast) to address these issues. Additionally, regular cash flow monitoring helps small business owners be more informed when making decisions about allocating funds to long-term growth initiatives (e.g., hiring additional staff, expanding to new locations) for their business. Note that there are several software options available that can track cash flow in real-time, which can be of substantial value to small business owners as they can view an accurate snapshot of their cash flow at any time enabling them to make quicker decisions. Usage of technology solutions can specifically help small business owners with invoicing (e.g., automated invoice creation, reminders to clients for overdue payments) and tracking of expenses (e.g., automatically categorize expenses for quicker analysis).
Maintain a strong liquidity position
Small business owners should maintain a strong liquidity position as it could be a buffer during challenging periods by allowing the business to meet immediate financial obligations (e.g., payroll, rent, etc.) without having to incur debt, which will keep their business operating without interruption. Strategies to build a strong liquidity position include allocating a portion of profits each month until the target cash reserve amount is reached and keeping these funds in a separate account designated as an emergency cash reserve. I illustrate with the following hypothetical example below.
Larry owns a marketing consulting company and has operated it successfully for 14 years. Five years ago, he decided to hire Jim who is a financial planner. Jim noticed that Larry did not maintain a strong liquidity position even though his company was operating profitably and recommended that Larry build an emergency cash reserve totaling six months of expenses. Larry followed Jim’s recommendation and started allocating funds each month to a savings account at his bank until reaching the six-month target cash reserve amount. This financial advice proved to be invaluable because Larry faced a challenging period where profits were much lower than usual but was still able to comfortably meet the current financial obligations of his business, which included paying the salaries of his employees who have supported him for 11 years.
Diversify streams of income
Depending on the specific situation, there could be opportunities for small business owners to diversify their income streams, which can be a strategy to stabilize cash flow. There is always the potential for markets to change so reliance on one source of income has risk. One way to diversify streams of income is to expand product and/or service lines with complementary products and/or services. I illustrate with the hypothetical example below.
Mary owns a health consulting company, and her primary source of income is ongoing health consulting services. She already has twenty ongoing clients but decided to diversify her streams of income by adding a one-time health consulting project service, which has helped the profitability of her business.
Evaluating your cash flow management
After a full review of their financial situation, I provide a cash flow assessment to each one of my small business owner clients and provide ongoing support in this area of cash flow management, which allows them to adjust strategies as they navigate business changes. I go through this item thoroughly with clients because it provides me with the necessary information to establish their capacity to save, which allows me to make appropriate recommendations on where they should be allocating their money.