I think you’ll agree that fluctuating cash flows are a massive source of stress for a small business owner. One day you’re riding high on piles of cash then suddenly your holding on with white knuckles as your cash flow plunges. It’s time to get off this wild ride by finding ways to increase your cash and smooth out your cash flows with good cash flow management.
There are three categories of tactics to do this:
- Speed up the collection of cash
- Slow down the outflow of cash
- Borrow on loans and savings accounts
Before we dive into those tactics, let’s talk about the one critical tool you need to manage your cash flow.
Reduce Cash Flow Management Surprises with a Cash Flow Forecast
Cash flow management is all about timing. It’s about making sure you will have cash available when you need it by receiving cash receipts sooner or pushing payments out later. Giving yourself more time to plan for potential times of low cash means giving yourself more options to avoid it.
The key tool for cash flow management is a cash flow projection. This is more important than any of your backward-looking income statements. Your forecast doesn’t have to be complicated or fancy.
Check out my blog post on creating a cash flow projection for more details about the benefits of a projection and how to create one. I also have a free cash flow projection template on my site that saves you from creating one from scratch.
Your forecast just needs to give you an estimate of when your cash inflows and outflows will occur. Pick a time frame that you think you can reasonably predict (for example, 1 month, 3 months, or 1 year). One option is to have a more detailed projection for the next 1-3 months and then a rougher projection for the following 4-12 months.
Putting the projection together is only preparation for action. Look at the times in the projection when you anticipate your cash balances to be low. You now have time to change the timing of cash flows to reduce these low spots of cash. This is cash flow management instead of cash flow reaction. You have lots of options, which are listed below.
Ways to Speed Up Cash Collection
1. Don’t Procrastinate: Ask for the Payment
The first tip in this section may seem the most obvious: ask for the money as soon as possible. Some owners are so busy working in the business that billing their customers slides to a lower priority. I’ve actually had to call contractors who worked on my rental houses to ask them to send me a bill so I can pay them.
The money due to you won’t arrive until you ask for it. You can bill before or at the time of service to accelerate cash inflows. If you bill after the service, make sure to do it as soon as possible. The longer you delay, the harder it is to collect payment.
2. Incentives for Quick Payment on Receivables
Sometimes your customers just need a little incentive to pay you more quickly. It’s very common for companies to state the following payment terms in their invoices:
- Due upon receipt – This communicates a sense of urgency which makes the customer more likely to pay your invoice immediately. Putting a due date in the future allows customers to delay until that date. They may have been completely fine to pay it immediately.
- Net 10 – If you consider “Due upon receipt” as too unreasonable, then pick a later due date. The number of days is totally up to you. The word “Net” followed by the number of days (10, 15, 30, etc.) communicates your expectation of when payment is due so your customer isn’t surprised when you call on payments that haven’t been received by then.
- 2% 10, Net 30 – This provides a discount to the customer for making a quick payment. In this example, the customer can reduce their payment to you by 2% for paying within 10 days, otherwise they should make their payment 30 days. Is offering this discount worth the cost to you? You have to assess your borrowing costs and the lost opportunities due to tight cash flow.
- Past due charge – If there is no penalty for paying late, some customers are happy to hold on as long as they can to the interest-free loan you are giving them. State a late fee that will be assessed if payment isn’t received by the due date.
3. Contact Your Past Due Customers
Your customers will take paying you as seriously as you are about collecting payments. Allowing payments to trail well after the due date trains the customers that they can pay you late. Monitor your past due report at least weekly to identify customers that need a call or email to nudge them to make a payment.
A tip is to ask them to respond to you with a commitment of when they will make their payment. They may not be able to make it immediately, but they must state when they can make the payment. All future conversations are then just holding them to their word.
I’m not saying to be unprofessional or disrespectful. At a credit union I worked for, the collections department manager reported to me and he told me that he trained his staff to always treat the borrowers respectfully. His practical definition for this was that the borrower would have a civil conversation with the collector if they ever ran into each other at a supermarket.
You can be empathetic without being enabling. You can be direct without being disrespectful.
4. Cash Management Services
Banks have ways to help you collect your money faster to automate cash flow management.
- Remote deposit capture – You can scan your deposits from your desk rather than having them sit until your next trip to the bank. When I was the CFO of a health clinic system, I would notice that our cash was sometimes low at payroll time. The clinics would have multiple day’s deposits of checks sitting in their desk drawers waiting for someone to take them to the bank. I would call to remind them to take the deposit to the bank because the funds to cover everyone’s paychecks were sitting in their desks.
- Lockbox – Having the bank make the deposit for you means the cash is credited to you even faster. Checks are mailed directly to a PO box where the bank picks them up, deposits them, and sends a file with the remittance info to you that can be posted to your accounting system.
- ACH, debit card, and credit card payments –Allowing customers to pay online or over the phone with an ACH payment, debit card, or credit card means not waiting for a check to arrive. An ACH (Automated Clearing House) payment is an electronic way to deduct funds directly from the customer’s checking account.
Factoring may be a cash flow management option for you if you want fast cash from your receivables but it comes at a cost. Let’s say you have $100,000 in outstanding invoices. The factoring company pays you 70-95% of that immediately and collects on those accounts. They will send to you any cash they receive on those invoices above the amount they already paid to you. That cash is subject to a factoring fee.
Ways to Slow Down the Outflow of Cash
Maybe the quickest way to summarize this next section is to take everything I said in the section above on how to speed up your receivables and to do the opposite when paying your bills. Let’s dive into a few more details.
6. Pay Your Bills as Late as Possible
You can’t afford to take discounts when paying your bills when cash flow is a constraint. If your vendor’s invoice states “2% 10, Net 30” you’re going to schedule it for payment in 30 days. If you are currently flush with cash, take the discount.
Check the invoice or your contract with the vendor for when late payment fees start to be charged. Make the payment before the due date. Pay just before they assess a late fee. A company that provides accounts payable and other cash flow management services can help you automate this. More sophisticated vendors may report your late payments to a business credit reporting bureau so you want to be very cautious about paying your bills on time.
One of the lessons I learned early in my career as an accountant is to not pay the late fee on an invoice. Some vendors will write this off if you make your payment. Others don’t and you’ll soon learn who will charge it you and who won’t.
7. Negotiate a Payment Plan
If it looks like you won’t be able to make your full payment before the due date, you can call the vendor to work out a payment plan. The worst thing you can do when you aren’t following payment terms is to not communicate. Being honest with your vendors allows both of you to work together towards the best solution for everyone. Not communicating greatly increases the odds that your vendor will see no choice but to take strong collections actions.
8. Business Operating Lines of Credit
Lines of credit are a standard liquidity option for financing operations of established businesses. These are usually granted for a one-year term. During that year you can draw on the line (usually transferred from your loan to your checking account) and pay down the line (an easy transfer from your checking account to the loan).
You make monthly interest payments based on the amount you had drawn on the line over the previous month. You may pay a fee based on the total amount you are able to borrow (i.e. the “commitment amount” of the loan).
A key thing to remember is that you need to “rest” the line occasionally. Resting the line means paying it down to zero. How often you are required to do this and how long it must stay at zero before you start drawing on it again differs with each lender.
The concept behind the line is that you need periodic financing for periods when cash is tight but you have other times of the year when you don’t need to borrow because you have enough cash. Operating lines are designed for occasional or seasonal cash needs, not a source of long-term funding.
Lines with amounts borrowed at all times are called “evergreen lines” and are not looked upon favorably by banks or banking regulators. Never resting the line may indicate you have cash flow issues and present a credit risk to the bank, who may limit your line or force principal and interest payments.
A source of funding that’s similar to a bank line of credit is trade financing from your major vendors. They allow you to buy inventory on credit. This allows you to pay them once you have received payment from your customers.
9. Term Financing
Term financing refers to loans that are made for a specific number of years (the “term” of the loan) and usually are paid down with principal and interest payments over the term of the loan. You could finance the purchase of equipment or real estate this way so you don’t have to draw down your cash reserves. You may also be able to refinance real estate you own at a lower rate or add a second loan to real estate in which you have large equity to get more cash for operations.
10. Personal savings
In this option, you are putting your assets in the company and there is no promise you’ll get that investment back. This may be one of your best options early in the company’s life. You will need to decide if you are making a capital contribution (equity infusion) to the company or just making a loan.
Having clear documentation of the term of the loan is very important if the company fails. Lenders have priority over stockholders in the liquidation of a company so you may have better odds of getting your cash back if it’s treated as a loan.
11. Personal Lines of Credit (Home Equity Lines of Credit, Unsecured Lines, and Credit Cards)
This may be the only bank loan option for new businesses. You may have a home equity line of credit, an unsecured personal line of credit, or it may just be credit cards. Be careful with these because you have now put your personal assets at risk by drawing on personal lines to fund the company.
I cringe even mentioning credit cards but I’ve been a banker for much of my life so I know how important credit cards are to many small businesses. There have been many small businesses that were first financed with the personal credit cards of the owner. When I worked at an agricultural bank, we knew about farmers who would use the credit card offers from other banks with teaser rates like 0% interest for six months to finance their operations for the season.
Using cards, especially multiple cards, can seriously hurt your credit score and the interest rates can be very high. Proceed with great caution if you are considering credit cards.
12. Friends and Family
When all else fails, you may ask your friends and family for loans. This may be your only choice when banks and other lenders just can’t take the risk of a loan to your business.
When I was in college, my dad was starting his business. I had some funds saved for college and he had a short-term need for cash so I loaned my cash to him and he quickly paid it back with interest. He continued to build a very successful business and made loans to other people.
Getting funds from friends and family can get very messy. It may be tempting to do something informally. That lack of clarity can come back to bite you. It’s worth writing out the terms of the agreement.
The first decision is to clarify whether this is a loan or an ownership investment in the company. If it’s a loan, you only owe them interest. If it’s an ownership investment, you just gave them rights to future income of the company. It may be clear to you that you only intended to make a loan but they may claim you offered them ownership. Make things clear with an agreement.
The loan agreement also clearly states the consequences if you can’t pay on time. It’s much easier to work this out now rather than when cash gets tight. Your friend or family lender may become scared if you’re struggling to make payments. They may require much bigger penalties than you ever imagined or demand immediate full repayment. Set the terms of the agreement while everyone has a level head.
The biggest concern with friends and family is to think through the impact on the relationship. Consider these questions:
- If you had cash struggles, would this damage the relationship?
- Is the loan worth jeopardizing the relationship?
- Would receiving this loan create the expectation that you are obligated to do something similar for the other person for the sake of the relationship? You may end up owing much more than the money you borrowed.
A Steady Stream of Cash Flow from Good Cash Flow Management
Running a business should be an exciting and fun adventure. Terrifying plunges in cash flow don’t need to be a part of it with good cash flow management. Check out my Complete Guide to Cash Flow Management to learn how I can help you do all this. Here’s to smooth sailing on a steady stream of cash flow!