In simple terms, cash flow is the amount of cash and/or cash-equivalents moving in and out of your business. To have a positive cash flow, the amount of money your business receives in a particular period (let’s say a month) needs to exceed the amount of money paid out. This liquidity is what enables you to pay expenses, settle debts, pay your shareholders, as well as grow the business by reinvesting.
Here are five effective ways to ensure you maintain a positive cash flow (see CreditWorks):
- Know your actual costs and expenses
One of the main reasons why many entrepreneurs find it difficult to maintain a positive cash flow is that they do not keep track of costs and the due dates for bills and other expenses. When you understand what your actual costs are, you’ll be able to calculate the breakeven point for the goods or services you sell. This way you’ll ensure that you charge enough to cover your costs and make a profit.
- Get your debtors to pay early
Encourage your clients to pay early and delay paying your creditors for as long as possible – without incurring interest or late fees, of course. Send out invoices to your clients immediately a product is delivered or work is completed to give them adequate time to plan for payment. You can offer small discounts (of about 3-5%) to customers who clear their accounts within a few days of receiving their bill.
Send friendly reminders to clients who are late on their payments and advise them of any late fees and interest charges that they will incur for late payment. You could also waive penalties for clients who have held the debt for too long to encourage them to pay up.
- Build your business credit
Manage your debts well to ensure your business has a good business credit. This will ensure that you can get big bank loans at affordable rates to boost your cash flow when the going gets tough – and this is bound to happen every once in a while.
Good business credit will also ensure that you get favourable credit terms from your suppliers further boosting your cash flow.
- Check your customer’s business credit
Before selling to a customer on credit, make sure you run a credit check on their business to ensure that they are healthy financially and have a high likelihood of paying you on time. Don’t just perform credit checks on new customers but on long-term customers as well as the financial situation of a business can change within a very short time.
- Create a cushion
Keep some reserves when things are good for that unforeseen rainy day. Maintain a cash reserve of at least 20% of revenues to protect and insulate your business during sudden revenue downturns and slower seasons. This will ensure that you are able to cover your costs and expenses for some time even if cash is not coming in as fast as it used to.
One of the most common (and catastrophic) mistakes most entrepreneurs make is focusing most of their attention on sales and profits at the expense of cash flow. Although they are both very important for a business to thrive, it is a positive cash flow that will ensure your doors remain open and your business does not go bankrupt in the short-term.