Recent events like bank collapses, cryptocurrency fluctuations, and market crashes can be viewed as significant upheavals, which raise the question: How can I best manage my cash flow in a way that not only preserves profit, but also prepares my business for future risks and challenges?
We’ve condensed as many practical approaches you can begin to take today to ensure that your business not only survives, but thrives, and remains successful amid volatile market conditions.
Clearing the air: Cash accounting vs. accrual accounting
Note that any decent cash flow management plan emphasizes cash accounting over accrual accounting.
Cash accounting takes a “liquid is real” approach. Whereas you’d usually record a credit transaction as a successful sale, cash-based accounting views it for what it is: money that isn’t yet in your hand and cannot be considered real.
Cash accounting doesn’t consider your business to be paid unless money actually exchanges hands. Records here follow the money, not the invoice issue date, which can be misleading.
Positive cash flow
The ideal balance that any good cash flow management strategy aims to strike is to have more money coming into the business than you have going out. In other words, positive cash flow.
Cash flow management tips for better liquidity
Cut down on overspending
Overspending doesn’t necessarily mean that you’re burning too much cash on futile expenses. It could have more to do with when you choose to spend or cover a particular expense. This is often overlooked.
Let’s say you run an online watch store, and business seems to be going well. You’ve bought an entire catalog from a wholesale dealer, $1,000 of which is on credit. Now, let’s say you’ve promised to pay them back the remaining amount during the final week of this month. You’re expecting a tidy sum of $1,500 in sales to come in by the end of the third week, and you have $2,000 in hand at the moment, half of which you plan to use to restock inventory.
Since you’re only due to pay your supplier by the month’s end, and you already expect a cash inflow from sales to cover the cost by then, you can delay paying bills that aren’t due yet. In this scenario, even if your entire credit sales customers end up defaulting, you’d still have enough to cover your reputation and pay off pending dues.
The question isn’t one of whether you need to pay your creditor’s bills or whether you need to restock inventory. Both are highly important. Rather, the question is when to pay each. The goal then becomes prioritizing expenses based on your existing and estimated cash flow.
Make choices based on cash flow
Allow your decisions to be informed by cash flow.
Let’s say you run an online sweater company. You’ve just shipped 70 items worth $10 each to your customers. You’ve already issued invoices and expect money to start flowing in as each product is delivered, and subsequently paid for upon fulfillment. But this will take another five days.
With you recent $700 in sales, which garners a 40% profit margin, you’re considering the immediate purchase of another 100 sweaters from your supplier in order to meet the growing demand. This purchase would, of course, be on a credit basis as you don’t have the money in hand just yet.
If you’re strictly adhering to a strategy based on cash flow then this decision would be unwise. Why? Because unless (and until) you receive the cash you’re owed from your recent sales, the revenue you’ve acquired is purely a projection. It doesn’t become tangible until you receive it.
Buying yet another 100 items on credit before you receive your actual cash will simply double your risk.
A cash flow expert would recommend stalling the next purchase for another week to wait and see how your sales turn out. Don’t make the order just yet, but inform your supplier that you are interested and will revert back. Provided everything goes well, you can easily restock your inventory without adding more cost. This isn’t a matter of revenue and loss, but rather of revenue and liquidity.
Only spend what you have in cash
A simple yet critical rule to follow when trying to keep your cash flow up and running is not to spend money you don’t have just yet.
If you’ve only made $1,000 in cash sales and have invoiced customers for another $1,000 in credit, don’t go purchasing the money you don’t yet have. In other words, don’t buy $2,000 worth of products when your real cash assets only amount to $1,000. Instead, wait for the money to flow in.
We often see this happening with businesses that are prone to higher risk. In a bid to boost sales with extra stock, a lot of sellers feel comfortable buying more inventory with the hopes of paying suppliers as soon as the credit sales customers come through. This poses an issue when those credit sales customers end up delaying payment, or worse, defaulting.
Improve cash revenue
When you begin to narrow it down, cash flow is improved through one of four channels: an increase in customers, average sales, frequency of sales, and a hike in prices. All four of these affect the actual amount of money that comes into your business, as opposed to just revenue.
Cash flow increases when you have an increase in customers and when your average sale amount is increased. For example: if an average item used to cost $10 but you now sell it for $12, your cash flow improves instantly with more repeat customers purchasing at the higher price point.
If pricing your products higher is not working to improve sales, you could try reducing overheads in procurement. By choosing more lenient suppliers, getting bulk purchase discounts, and making do with your garage as a storage space, there are plenty of expenses that can be minimized.
Run a sale for fast cash injections
The goal of running quick discounted sales is not to increase profit, at least not exclusively, but it’s about converting surplus items that are stalling your cash flow. This way, you can inject more liquidity into your business, especially during emergencies. You might have to make a call between hoping to maximize profit versus gaining access to cash at a slightly lesser margin than expected.
Plan ahead to overcome payables
Always remember to sequence your receivables to come ahead of your payables. Even if only some of your clients pay on time, you’ll still have enough cash from sales to match and cover expenses you’ve incurred in payables.
If the payment you owe your supplier is due on the 30th of next month then you should invoice your customers to pay by at least the 10th of the same month. The extra 20 days will give you a wide berth and safety margin to put you at ease. Worst-case scenario is all of them default, which is unlikely. Though even if this did happen, you’ll still have plenty of time to figure out how to meet your due payments.
Introduce preferred payment methods
Sometimes customers might have cash lying around in their bank account but not in hand. Some might be more than willing to pay you through an online portal. The key is to integrate all preferred payment options so that you can allow them to conveniently speed up purchases.
A quick note on invoice factoring:
Invoice factoring is tricky. It’s a process where you sell the debt you’re owed to a third party. They discount a percentage of the value, pay you in advance, and then proceed to collect your debt from the customers who owe you later on, in full. Businesses that are desperately in need of cash and have no way of enforcing the recovery of defaulters usually resort to this option. However, it may not be the best alternative as it forces you to suffer a percentage of loss in exchange for getting money upfront.
Handle debts through smart refinancing
For a lot of online businesses, the real dent in cash flow comes from high-interest debt. There’s hardly going to be any surplus for you to work with if 80% of your revenue goes into paying back your credit card loan. Refinancing your debt can help take some of the weight off your shoulders, and help you save at least a bit more cash.
The idea is simple: You take out a loan with slightly more favorable terms (say 9%) to pay off a debt that’s a bit higher (say 13%). It will reduce your cash burden significantly, giving you that extra 4% in cash difference to work with. As time progresses, you can try to see if you can refinance the remainder of the 9% loan with another favorable one. This helps you manage cash flow in a way that you have access to more money without constantly worrying about your loan.
Optimize your revenue cycle
Here’s a common scenario that many online retailers may find themselves in:
Let’s say you own a niche online sportswear company. You’ve bought your goods wholesale, and sales have exceeded expectations. However, you’ve purchased these products on credit and your bill is now due today. Your debtors owe you money that could more than easily offset the amount you owe suppliers, but there’s a catch. Their bill doesn’t come due until another two weeks.
This is a problem that arises when you don’t plan your revenue cycles to account for bills you owe. In an ideal scenario, you should plan your customers’ bills to be collected at least two weeks ahead of your own. This way, you can manage delays and get an emergency injection in case you need it.
Stay on top of taxes
Many new online sellers fail to plan for taxes. You must be well-acquainted with the tax laws and policies when you’re doing business, which helps you determine how much you should have in cash reserves.
Maintain a six-month emergency reserve
One of the common features of any decent cash flow plan is having an emergency cash injection strategy. This could be someone you trust, like a private investor or a friend who is willing to lend you money should the need arise, or an institution like a bank or a micro-financing firm.
These are backup plans for scenarios that hopefully never arise, but you need to be prepared for them just in case they do.
Forecast for the worst
The goal behind cash outflow and inflow projections isn’t accuracy, but conservation. When you have a somewhat average figure or ballpark that you’re trying to hit, or a margin you’re trying to stay within, then you’re less likely to make any rash cash-related decisions. It sets a parameter around which you can contain your expenditure even when your revenue isn’t meeting standards.
A general formula that business owners use for this is to add your existing cash to the difference between estimated cash inflow and outflow. This gives you a rough and reliable figure for each period you’re attempting to forecast.
Play it safe. Grow with caution.
A key point to note when you try scaling your business is the gap between cash inflow and outflow. Hiring more people, and products, and adding more warehouses to store your inventory are all cash-burning activities that bring more risk to your business.
The longer the delay in getting cash sales to justify the cost of expansion, the more likely your business is to fail. This is why you need to emphasize growing with caution over reckless growth.
Automate invoices to avoid delays
You can only begin to hold your customers liable for any delay in payments based on the date you’ve issued an actual invoice to them. This is where the countdown starts. Automating your sales process to issue instant invoices as soon as a sale is made can greatly help alleviate worries in this regard. Most book-keeping softwares allow you to do this.
Stay updated on your BEP
Calculating your break-even point every month is one of the first things any business that’s good at cash flow management does. Find out what costs you incur in procurement and delivery so that you can not only factor that into your sales price, but also estimate the limit for credit sales you can take before it becomes too risky.
Retain an advance deposit for extra caution
It is never a good idea to undertake any project or ship any product without at least retaining some of the amounts in advance deposits. Charging a $50 advance for a $200 product could be feasible, especially considering the shipping and delivery costs you’d have to cover. Initial deposits and advances also help in weeding out unreliable customers who don’t plan on paying on time.
Motivate your customers to pay early
Slapping a penalty for late payments may sound like a good idea to try, especially with unreliable clients, but is it really any more effective? A valuable lesson that most business owners learn early on is that people respond better to incentives than they do to deterrents.
Instead of charging extra for delayed payments, you could try encouraging customers to pay early by promising a small discount for those who make it within the first week. Increase the discount for special clients who are willing to pay the full amount in advance, which also helps direct more cash flow into your business. Not only is this a practical way to save yourself the hassle of defaulting debtors, but it could also be a boost to sales.
Actual liquidity beats profit on paper
Instead of mixing up cash and credit earnings to see how they measure up against your break-even point, tally up cash sales alone and find out how close the number is to your BEP. If you’re able to generate a profit with cash sales alone, your business is in much safer waters.
It is better to have a conservative estimate of where your business stands in regards to profit rather than trust an exaggerated version that could potentially be wrong by a significant margin. Ideally, it is unhealthy for a business to have more than 30% of its sales in credit.
A smart way to decide how much you need to reduce credit is to clearly define all your expenses first, then see how much of it you can cover using your existing cash flow alone, in case all your debtors end up defaulting.
You own a footwear business that incurs $10,000 in monthly expenses. Your total cash and credit sales amount to $6,000 and $7,000, respectively. Your total cash earnings at present ($6,000) are still 40% short when it comes to covering your overall monthly expenses, which include production/ procurement costs. What would happen in the unfortunate situation that your debtors don’t pay you back? Sure, you could pursue the legal route, but how long is that likely to take, and how much time is that going to drain away when you could be paying attention to a business that you’re running?
Furthermore, if you regularly rely on past months’ surplus money to cover present costs, then you should seriously reconsider how your business is structured. A model of business that relies heavily on credit over cash is not sustainable.
Upgrade your tech
Manual processes are not only tedious but also cash-draining in the sense that they drain a lot of the time you could be spending elsewhere. Most accounting software is built to automate 90% of all the mundane activities your business carries out. This is one example of redirecting cash flow into an investment that will yield far more returns in the form of reduced time and cost.
Pprioritizing their expenses is a key area where most online sellers fail when it comes to cash flow management. Yes, your reputation as a business means a great deal, but that hardly means that all bills are equally important.
If you have multiple bills due on credit, you could prioritize the ones from frequent and regular suppliers over others, at least in the order you’re paying them off. This doesn’t mean you should delay them past their due date, which could adversely affect future deals. You need only stall them for as long as necessary to use existing cash flow effectively.
Your online footwear business has excess cash dedicated to expenses in the figure of $2,000. You owe a relatively small sum of $1,000 to a one-time supplier. Let’s say you have yet another regular supplier to whom you owe $1,500. Both are due around the end of the month. You could try paying your frequent collaborator in the first week, and the other in the last.
Liquidate fast: Clear out excess inventory, even at low margins
How excess inventory affects your cash flow is obvious even to beginner sellers. It is the simple fact that all of that money is tied into goods that aren’t being converted just as quickly into cash. This can be a recurring headache for online retailers, especially if you don’t have a clear-cut strategy on how much stock you’re willing to retain.
Let’s say you’re an online seller who specializes in ornate ceramic mugs. Each item of stock that you stash up in storage is money being pumped into inventory. On average, a regular mug cost $10. If the most you’re willing to part with is $1,000 in inventory, then any number of mugs above your threshold (1000/10=100) has to go.
Suppose you’re hoarding an excess of 50 mugs. That’s an average of $500 you have tied into inventory and have no access to. You can help get yourself out of this by hosting a flash sale or discounting the price right until you get your inventory down to the desired limit.
There is no one-size-fits-all approach. The most commonly adopted methods we’ve covered here have proven to be reliable strategies that most businesses often choose in order to control and manage their cash flow effectively. We recommend getting creative when deciding which strategies could work best for your business based on your own goals and constraints.