Managing cash flow is perhaps the hardest aspect of growing a small business. Even successful and profitable businesses run into periodic cash flow challenges. There are some common mistakes that business owners often make as they try to manage their cash flow. Understanding these simple mistakes and how to avoid them can make the difference between a business being successful or being highly successful.
Here are six cash flow mistakes companies often make:
#1 Failure to Forecast
Many companies do not forecast their cash flows often or accurately enough. Not understanding the liquidity demands of your business could lead to a cash flow challenge that hinders your growth. A business owner must have realistic and accurate forecasts about both revenues and expenses, and the timing of the cash flow requirements for each. Not forecasting often enough or accurately enough can lead to your business experiencing liquidity problems.
#2 Paying Short-Term Liabilities with Long-Term Debt
When faced with short-term liquidity challenge many companies will often turn to a bank loan or some other form of long-term debt to meet their cash flow needs. This common mistake can saddle a company with unnecessary long-term debt and cost the company significantly more in financing in bank fees over time. Financing tools such as purchase order financing or contract financing allow a company to get cash flow from a current project or contract without taking on long-term debt.
#3 Putting it on the Card
Many companies use the corporate credit card as a primary short-term financing tool. While this can be a convenient way to pay expenses it can also lead to long-term debt and larger interest expenses. Also, if the company does not properly track the interest and other expenses associated with the credit card, it may not be fully accounting for the cost of goods sold on a particular order. Financing a project or contract with a debt tool that is specifically for that purpose, such as with a purchase order loan or a contract loan, will allow the business to know its true profit margin on a project.
#4 Slow Invoicing or Collections
Invoices are the lifeblood of any small business. Invoicing your customers slowly or inconsistently can lead to cash flow problems, even if your business is very successful. Similarly, the speed at which your customers pay can also constrain your liquidity. While it is difficult to control how quickly customers pay, negotiating favorable payment times and encouraging early payments can positively impact cash flow. At a minimum, promptly invoicing clients will help ensure a company is getting paid for its work on a timely basis.
#5 Turning Down a Project or Order for Cash Flow Reasons
There are many financing tools available to help a company meet short-term cash flow needs. Turning down a new or large order because the company does not have sufficient liquidity to meet the cash flow needs of the project can significantly hinder the company’s growth. It can also cost the company not only the value of the current contract, but also the long-term business relationship with that client. Financial tools like purchase order financing and contract loans can help companies meet the cash flow demands of new or large orders, so that they do not have to turn them down.
#6 Not Saving Enough for Rainy Days
The most obvious mistake many small businesses make is not saving adequate cash reserves to meet normal business cycles. Every business goes through ups and downs. It is critical for a business owner to understand its business cycles and save cash reserves to meet them. Nothing helps smooth a spike in cash flow demand like having sufficient cash reserves. Many businesses fail to accurately estimate the ups and down of their business cycles and, therefore, underestimate the cash reserves they need.
Managing cash flow can be the hardest part of running a small business. Understanding the common mistakes that many businesses make can help a business owner avoid them. Good cash flow management practices will enable a company grow to its fullest potential and beyond.