5 practical steps: how to manage cash flow in a small business
You could have the best business idea ever. You could have major customers queuing up at the door. You could have a huge order on the books which would make you a millionaire. But, if you don’t know how to manage cash flow in a small business, none of that will matter.
Cash flow problems are reported to kill almost a third of small businesses, so if your company’s income is not stable, you could find yourself in financial difficulties.
Fortunately, you can avoid the sleepless nights by taking some simple steps to organise your finances. So, let’s look at how to manage cash flow in a small business.
What is cashflow?
Meet Claire. She’s a web designer who started out as a sole trader before deciding to hire a couple of staff to launch a web-design agency.
Now, after a couple of months of smaller jobs, Claire is excited to win a contract with a big client to redesign their entire website – a project which will take all her team’s time and energy for the next couple of months.
After a good start, the project is taking longer than initially expected as one of Claire’s team gets ill for a couple of weeks. Then, the client’s requirements change. By month three of the project, Claire realises she’s not going to be able to pay both her staff their full wages. On hearing the news, one of them threatens to quit, so Claire chooses not to pay herself. Even then, once the project is finally completed, the client takes months to actually pay up.
In the meantime, this cash flow problem has meant Claire has had to close her company.
So, how can you avoid this kind of scenario?
How to manage cash flow in a small business in 5 steps
Here’s how to manage cash flow in a small business in 5 simple steps:
1. Keep all records of income and outgoings
If you don’t know what’s coming into and going out of your company’s accounts, it’s extremely difficult to monitor your cash flow. You might believe that you’re earning a healthy profit, but if you don’t have the data, you’re just left guessing.
Accurate record keeping will ensure you know exactly what the business is making and help you make better decisions about what to do with the company’s money. If you have accounting software, this can be done very easily, although a simple spreadsheet can do you just as well to begin with. Simply keep a log of all the money the business spends and receives.
2. Cashflow statement and forecast
Creating a cashflow forecast is essential for managing your small business’s finances. This is a simple chart where you track:
- The cash incoming on a monthly basis
This is all the payments you’ve invoiced and expect to receive that month
- Cash outgoing on a monthly basis
This covers paying staff, setting aside cash for tax and all your other expenses, like office space and your bills
- Your actual month-end bank balance
This shows what actually ended up in your account at the end of the month
By punching this data into a spreadsheet, you can very quickly get an idea of what your real profit is, and how you’re doing over time. As your business grows, you need to closely monitor your cashflow statement and your forecasts. Is the cash coming in high enough above your expenses? Are clients paying on time, or is your month-end bank balance lower than it should be?
3. Monthly accounts management review
It’s very sensible to carry out a monthly accounts review. Set aside some time each month to review your progress and get an idea of where you are and how things are going. This will help you ‘see the wood for the trees’ and give you the time to make any changes in strategy. You might, for instance, decide that one of your clients just isn’t paying enough to make it worth working with them anymore, for instance.
4. Looking ahead and setting tax aside
When you’re busy and have a lot of work on, it can be easy to forget some of the essentials of small business finances. But, this can be a killer. Generally, you need to be monitoring your reserves and setting aside money for the future:
- Aim to have at least 3 to 6 months’ cash set aside to pay yourself and your staff to help cover you during any ‘down’ periods
- Also, set aside a proportion of anything you earn for when the time comes to paying tax
5. Invoicing best practice
Last of all, there are a number of things you can do to make it more likely your invoices get paid on time, so your accounting is more predictable:
- Specify an invoice payment due date on all your invoices
- Ensure your invoices are formatted correctly with invoice date, unit prices, VAT and other details – some clients may refuse to pay an invoice which is not clearly laid out
- Follow up outstanding invoices quickly
- You might want to add a penalty clause in your invoices for late payment – although if you’re starting out, you don’t want to develop a bad relationship with clients
Simple steps for secure small business finances
By preparing your company’s finances, you make sure your business grows on solid foundations. This helps you make better decisions about what projects you can and can’t take on, choose when to invest, or decide to cut back on your outgoings so you don’t overspend.
At DSL, we pride ourselves on helping small businesses put in solid financial foundations to help them grow fast. Talk to our friendly team today about managing your company’s finances and cashflow.