Cash is queen in a business and managing your cash flow effectively will increase the success in your business. Unfortunately, more than 80 percent of businesses fail due to cash flow issues, highlighting the importance of having a cash management system in your business. Cash flow isn’t just important – it is a non-negotiable aspect for long term business success.
If you’re a small business owner, understanding and avoiding common cash flow mistakes will give you a competitive advantage. By proactively managing your cash flow, you can protect your business from financial setbacks and confidently manage your business.
Here are some common mistakes you can avoid making with your cash flow:
1. Confusing profit with cash flow
Many business owners believe that if your business is profitable, cash will always be in abundance. But the real issue is that cash and profit are not the same. Profit reflects the financial performance of the business, where cash flow is what you need to meet the day-to-day operational requirements.
Tip: To avoid this, create a cash flow forecast to follow the flow of your cash and anticipate cash flow issues before they happen.
2. Failing to plan for seasonal fluctuations
For many businesses there will be peaks and valleys in sales. Sales may soar during certain months and leave other months with significant cash flow challenges. Without a financial cushion, you may struggle to cover expenses during slow periods in your business.
Tip: Save a portion of your peak-season earnings to cover the slower months.
3. Ignoring accounts receivable
If you are chasing late payments from clients, you are not alone. Late payments can create cash flow gaps and disrupt operations. Unpaid invoices essentially mean that you are lending money to your clients, often without interest, while your own expenses are piling up.
Tip: Set clear payment terms, send automated reminders for collection when late, and offer small discounts for early payments.
4. Poor inventory management
Inventory can be the largest expense for product-based businesses. Overstocking on inventory ties up cash in unsold goods and understocking leads to missed sales opportunities. Both scenarios can hurt your cash flow and overall profitability.
Tip: Track inventory levels and use historical data to predict demand.
5. Not monitoring expenses
Small, recurring expenses add up over time. It is smart to monitor your expenses regularly and catch any unnecessary costs that are eating away at your cash flow. Unchecked expenses are a cash drain.
Tip: Use budgeting tools to track spending and review regularly to avoid cash waste.
6. No cash reserve
Surprises happen in business and unexpected downturns or expenses will occur. It’s smart to have a cash reserve for these instances, instead of turning to expensive loans or credit cards to handle cash shortages. Debt from unplanned borrowing can spiral out of control and add unnecessary stress and expense.
Tip: Set aside three to six months of operating expenses for emergencies.
7. Taking on too much debt
Debt can be a useful tool for business growth, but too much debt can strain your cash flow and put your business at risk. High monthly payments reduce the cash available needed for daily operations and stunt any potential business growth.
Tip: Avoid using loans for recurring payments like payroll and rent and only use debt for specific high return investments such as revenue-generating equipment.
The bottom line is that cash flow management is not the same as profit and needs to be managed carefully. You can be a profitable business but if there is a cash flow bottleneck in your cash management system, it could put your business at risk. It is recommended to proactively monitor your cash flow, continually updating cash flow projections for six to eight weeks out. Managing your cash flow effectively can be the best investment you make for your business.