Are you afraid that your entity might run out of cash even if it is profitable? Do you reconsider or postpone taking sound business decisions because of a potential cash crunch? If yes, it is probably time to take cash flow management more seriously.
Commencing one’s own business is quite difficult as it is. One has to learn and implement everything from marketing to legal compliance. An important part of the operations is managing the finances, especially the cash flows. Even though your business may be profitable, it is quite possible that a fund crunch may be on the cards or may have even been encountered. This is especially true for new organisations since the capital expenses may be high and the quantum of cash generated from revenues is not yet adequate to meet the expenses. It is also difficult to negotiate for deferred payments to your suppliers or ask for advances/quick payments from customers since you are an entrant into the market.
5 Ways To Simplify Cash Flow Management For Your Small Business
Liquidity is very important, especially if you want approvals or loan sanctions or even credit ratings from banks or other lenders. This is because they take your cash position into account and if it is not satisfactory, your business might lose out on opportunities to grow further. To avoid this situation, the 5 points mentioned below for cash flow management might come in handy.
1. Create a reserve
Certain types of companies are mandated to appropriate a part of their profits into an untouched fund or reserve which is used only during financial emergencies for the company. The same can be practised by a small business owner for cash flow management.
While it may pinch in the short run and appear that the potential for growth by reinvesting the entire profit amount is not achieved, this is one way to ensure that funds are available if and when cash flows from other sources are inadequate to run the business without any interruptions due to a shortage of liquid funds.
This ‘reserve’ must be seen as a rainy day fund, and conditions for its use must be set beforehand so that it is not utilised when there is no real emergency.
Investment of the reserve fund:
The money that is in this fund can be invested in a highly liquid investment avenue or one in which the money can be easily accessed. This way, the money is not lying idle in your bank account and is earning some returns while being kept safe. Another advantage of investing this fund money is that the temptation to use it is also reduced since it delivers returns and there’s a procedure to access it.
2. Prepare a cash budget
As the owner of a small business, it is highly likely that you have prepared the basic financial statements – a projected income statement (also called profit and loss statement) and balance sheet for one year into the future or a longer period.
In addition to this, preparing a monthly cash budget can help you plan your major expenses, understand your funding requirement and decide when or where to tighten the strings.
Some terms pertaining to preparing a cash budget:
- A cash budget consists of the inflows and outflows of cash for a particular period (a monthly cash budget will be for one month).
- The cash requirement for the first month is the difference between the aggregate of the receipts and that of the payments.
- A positive amount represents the cash balance and is carried forward to the next month while a negative amount represents a dearth of liquid funds. Further arrangement needs to be made if the latter situation arises in order to ensure that the business runs smoothly without being severely impacted by a cash crunch.
- It is not necessary that every line item has to have a corresponding amount for each period. These are represented by zeroes.
3. Negotiate with your neighbours in the supply chain
The neighbours of a small business in the supply chain are the immediate suppliers of various resources required (material, labour and other inputs) and the customers who purchase the commodity. One can negotiate with suppliers for an extended credit period. In return, you can assure them of a certain quantum of business for them so that they have guaranteed sales.
- You can induce your customers to pay the full purchase price by offering a cash discount (discount for cash payments) on the selling price.
- You can schedule your receipts and payments such that they are within a few days of each other so that there is always sufficient cash to meet your deadlines with creditors.
4. Inventory management
Inventory management involves estimating the inventory required, producing or procuring the same and storing it until it is sold. This is an important aid in cash flow management since funds are involved in creating the inventory.
It is common for enthusiastic small business owners to overproduce or overstock thus spending most of their cash on the materials for the same, leaving little to run the business until the time the stock is sold and generates cash inflow by way of revenue. To avoid such a situation, one first has to estimate the necessary units or inventory. This way, cash is not used too quickly, i.e. before the receipts start flowing steadily.
A few common methods followed to forecast the requirement:
- On the basis of demand
- Percentage of production capacity
- Economic order quantity (EOQ)
- Based on targets, if any (backed by a rationale)
5. Making short-term sources of financing accessible
Even if you are prepared, you may face a cash crunch which is beyond our ability to manage. For such situations, it is better to have an external source of funding which is within reach. A common informal way is to borrow from close friends or family. However, this may not be possible or may affect the personal equation of the small business owner.
Having a line of credit with a bank from which funds can be accessed on a need basis is one guaranteed source of external funding, thereby helping with cash flow management.
Alternatively, one could also apply for unsecured small business loans from institutions like NBFCs and the like.
An important thing to keep in mind, when it comes to cash flow management, is to segregate long-term and short-term assets and liabilities. As far as possible, long-term assets (such as equipment) should be funded by long-term liabilities (a bank loan) or equity (own long-term funds). This will ensure that all the cash outflows do not go only towards capital expenses, thus leaving next to nothing for operational expenses.
Profits might fluctuate. But it is liquidity that impacts business continuity more than profitability. In other words, if a business does not have adequate funds as cash or cash equivalents, it is difficult to run the business and make it more profitable. Hence, it is imperative to have a cash flow plan in mind.
If you need assistance to help you out during a cash crunch and need unsecured small business loans, get in touch with Gromor right away!