Increased revenue growth and net profit are typically the first two things that spring to mind when people think about what makes a business successful. But when it comes to whether a venture lives to see another day, there’s another critical piece to consider too: cash flow, which is the incomings and outgoings of cash or cash equivalents in a business.
According to the U.S. Small Business Administration, an estimated 20 percent of small businesses go belly up in the first year, and about half shutter within the first five years. More than 80 percent of the time, the blame lies with cash flow problems. Even businesses that generate revenue and profit can go bankrupt if cash flow issues arise, particularly if your balance sheet consistently sees red.
“Good cash management brings stability to a business, which provides the ability to choose customers and vendors, plan growth and negotiate the best terms,” explains Hal Shelton, an angel investor and author of the bestselling guide “The Secrets to Writing a Successful Business Plan.” Shelton also volunteers with SCORE, a nonprofit organization that provides free, personalized business mentoring services to prospective and established small business owners.
Of course, in order to keep your business afloat, you need money in the bank to cover operational expenditures. These can include payables like rent or mortgage, employee wages, production materials, monthly loan payments and other bills. The cash you use to make these payments may be rolling in from a variety of sources, including: customers purchasing your products or services, investors, crowdfunding campaigns, or loans and lines of credit. Any time more money is flowing in rather than out, your business is in a cash flow positive position. On the flip side, if you’re spending more than you’re bringing in, your business is in a cash flow negative situation.
You always want to avoid the latter position as much as possible, says Rick Williams, founder and managing director of Williams Advisory Partners in Boston. The firm specializes in CEO and board advisory services for middle-market technology companies.
“The first rule is don't run out of cash,” Williams says. “But people do. Big companies run out of cash. On some level, it sounds trivial to say, but it’s not trivial at all. What happens is, at the point when you realize you’re close to running out of cash, or you see you're going to run out of cash next month or even three months from now, it's almost too late to do anything about it.”
What can you do to keep your ledger in the black? The first thing is to closely monitor your business cash flow. Project your shortfalls and cash needs well in advance so you can take effective action when the time comes, as it certainly will. One misconception many first-time business owners have is that they only need to prepare cash flow projections once a year at budget time.
“Not true. You need to project cash flow every month and extend it 12 months—a rolling 12-month forecast,” says Shelton. “If the company has cash issues, the cash projection might be every week.”
"You need to project cash flow every month and extend it 12 months—a rolling 12-month forecast."
One business Shelton recalls working with—an enterprise software company with long sales cycles and big contract cycles—was forced to go from monthly to weekly cash flow reporting when it encountered cash flow problems. Luckily, the company spotted the shortfall far enough in advance to formulate a plan to work past the hurdle. It included holding vendor payments, cutting employees, temporarily reducing payroll and working with customers to pay invoices early. These measures, while never ideal, allowed the company to generate additional cash and eventually pull itself out of the hole.
It’s a cautionary tale for all business owners that illustrates the importance of maintaining your cash flow projections. Another thing to keep in mind, reminds Shelton, is that unless you are personally infusing cash into the business, most other means of obtaining funding—a bank term loan, online lending, crowdfunding campaigns, angel investors, etc.—don’t happen overnight. So, remember to leave yourself time to tap into one of these funding sources. Otherwise, he says, “You will have no option but to fund the company yourself, or accept whatever terms are demanded by the funder.”
Oftentimes, it is growing companies that are caught off guard by cash crunches, Shelton says. Why? As a business grows, it naturally needs to produce more product, hire more staff and kick up operations, so you’re spending more before getting paid.
As an entrepreneur, you should “always be raising,” advises Sweta Patel, a startup marketing advisor and founder of Silicon Valley Startup Marketing, a source for entrepreneurs to gain the insights they need to market, grow and scale their companies. “You can never have enough investors, if you're taking that route, and they want to see that you have at least six months of cash flow left in your business before they invest. But a lot of the CEOs I work with, they wait maybe three to six months before they are going to run out of cash [before fundraising again], which really leads them to fail.”
In other words, build up your cash reserves during positive cash flow cycles, so you have cushions of capital “to take you through the periods in which you may have lower revenues or higher expenses,” recommends Williams. One tactic you may consider is allocating a certain percentage of your profits each month to deposit into a separate business checking account or high-yield business savings account earmarked specifically for emergencies.
Make utilizing a rewards-based credit card, whether it’s cash rewards or mileage rewards, part of your company’s toolkit too, no matter what the cash situation is, says Shelton. And as a plan B, Williams adds, this would also be a good time to apply for a loan or set up a line of credit with the bank, even if you’re not going to draw from it immediately.
Applying for a loan can make a lot of sense for small businesses wanting to secure additional financing, and the U.S. Small Business Administration (SBA) is a great place to start. The federal agency partners with lenders such as banks to provide guaranteed loans to eligible small businesses. Loan amounts can range anywhere from $500 to $5 million and can be used toward most business purposes, including working capital and long-term fixed assets such as equipment purchase. For real estate loans, some banks may lend up to $15 million.
The SBA’s flagship 7(a) loan program guarantees up to 85 percent of SBA loans of $150,000 or less. Loan amounts higher than that are guaranteed up to 75 percent. Reducing the risk to the lender allows them to offer longer, more flexible terms and lower interest rates to borrowers than non-guaranteed loans. As a result, your monthly loan payments will be lower, and the cash flow required for eligibility also becomes lower, thereby increasing your odds of getting approved for an SBA loan, explains Wai-Chun Li, senior vice president and manager of East West Bank’s SBA lending department.
For the most part, a business that has filed a one-year tax return and can show at least one year’s repayment ability will likely qualify for an SBA loan from East West Bank, says Li. However, they would also consider financing a startup that has “an acceptable business plan and can demonstrate strong mitigating factors that offset the risk,” he says. This can include previous experience in that line of business, a good credit score and a good secondary source of income.
Overall, you’ll face less hassle when it comes to SBA loans versus conventional programs. Take real estate loans, says Li: “We can give full amortization for 25 years, which means during the term of the loan you won’t need to refinance.” So, you won’t have to shell out extra cash for a new appraisal or environmental report, or for all of the associated loan fees. Not to mention, there’s a lower down payment requirement for real estate: 10 percent minimum compared to up to 40 percent required by a conventional lender.
This all translates to bigger savings, and that means more cash can be diverted to other areas of the business—perhaps for product development or a marketing campaign to help boost sales. But again, don’t wait until you’re under the gun to apply. If you qualify, it usually takes 30-45 days to fund a loan, and sometimes up to 60 days if real estate is involved, says Li.
If for some reason you don’t qualify for a loan, here is another pro-tip for improving cash flow: Develop a lean, realistic operating budget. This allows you to visualize your expenses for a set period of time and helps keep your spending on track. (Although, it’s always a good idea to build in a contingency plan for unexpected changes that may crop up.) The rationale is that being conservative in flush times will help you save more, so you’ll have extra cash on hand if the going gets rough.
One frugal piece of advice Patel often gives her CEO clients is to avoid investing in every newfangled tool out there: “Keep it simple and solid and just enough to build a foundation and monitor that foundation. Think about your productivity cost versus the tool cost—is it worth it? Is the cost of a $300 or $400 monthly subscription actually worth implementing in your business? Is it going to save you money in the long term?”
Still, while budgeting lean can be smart, you should also be careful not to be a slave to it, says Shelton. “Small businesses need to be flexible and agile, and if this means spending more than budgeted to take advantage of an opportunity—then you might do it and find ways to close the temporary cash flow gap,” he explains.
Keeping cash flow in the positive can also be achieved by looking at the finer details. If you work with vendors, try negotiating for longer billing cycles—for instance, ask for a net-60 or a net-90 billing cycle rather than a net-30. (Do this if you’re facing a shortfall, as well.) And always be sure to pay on time to avoid late charges. This can be done by setting up an electronic funds transfer to automatically send payments on due dates and will help you to retain funds for as long as possible too.
“If you have monthly contracts with customers, try to move them to annual, with payment upfront; if you have annual contracts, try to get three-year contracts, with payment at the beginning of each year.”
Meanwhile, designate someone you trust to stay on top of accounts receivables and follow up with slow-paying customers. Shelton also suggests that “if you have monthly contracts with customers, try to move them to annual, with payment upfront; if you have annual contracts, try to get three-year contracts, with payment at the beginning of each year.” He recommends arranging customer payments via credit card, PayPal, wire transfer or other electronic payment, which tend to be faster than payment by check. You can incentivize early payments by offering discounts as well.
If anything, you can always invest in hiring a quality financial professional who will be proactive about helping you effectively manage your cash flow. Don’t leave it all up to the accountant, though. As a business owner, you need to have at the top of your mind what the impact of your decisions and actions will be too, says Shelton.
But if cash flow management still seems like a foreign language, don’t despair—you don’t need any special skills to crunch the numbers, he reassures. “Cash flow is easier to calculate than income, with all its accounting rules. Forecast the cash coming in and the cash going out, and you have it,” he says. “Of course, you need an understanding of your business and what makes it tick—but you need to know this to be an effective entrepreneur.”