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Salt Lake City Bookkeeping Blog

Cash Flow Management for Small Businesses

Posted by Matt Roberge on Sep 17, 2020 7:27:00 AM

Cash flow management became a big concern for a lot of businesses this year, especially after COVID really set in. The problem was that most businesses not only didn't have a good handle on their cash flow, but their accounting system was not set up in a manner that made cash flow management possible. 

First of all, what the heck is cash flow management anyway? To put it quite simply, cash flow management is a way to analyze and manage how much cash is coming in and out of your business over a certain time period. If done properly, you should be able to identify both cash flow shortages and surpluses. If you can get a handle on your cash flow it will greatly reduce your stress and allow you to develop and implement business strategy much more easily.

So, let's jump into how to develop a cash flow management system for your small business.

 

cash-flow delta-1

 

Develop an accounting system that supports cash flow management

 

Cash flow management starts with the development of a good bookkeeping system that will allow you to actually manage cash flow. So, what exactly does that mean?

 

Automatic payments or accounts receivable 

 

First, you need to set up a system to control the inflow of money into your business. The biggest mistake I see businesses make is allowing too many forms of payment. You can buy through their website through an external processor, you can pay through PayPal, you can pay by check, you can pay by wire, or even cash. All this leads to confusion and a lack of uniformity in the system.

Have you ever bought something online and then a message popped up that said: please contact us to tell us how you would like to pay and when? No, definitely not. But rather, please enter your credit card information, and here are the forms of payment we accept. Stop taking every form of payment and allowing your customers to dictate how you run your business. Focus on payment methods that lower accounts receivable days, speed up cash flow, and are automated within your accounting system. 

Ideally, all your customers would pay electronically and automatically through a credit card. That way you control when they pay and get instantaneous verification that the payment is authorized. We have clients often complain about merchant fees saying they can't afford them and prefer to wait for checks. The problem is that you can't control your cash flow effectively when you accept checks. If you accept checks think about how much time you spend stressing over your open accounts receivable report, following up with customers, dealing with bank deposits, and bounced checks.

It's not worth it!

According to Intuit's data you get paid two times faster when you invoice through QuickBooks and allow customers to pay electronically. This is based on data from QuickBooks Online customers from August 2016 to July 2017. I suspect that has only improved as so many customers prefer to pay electronically rather than manually through bank bill pay or paper check.  

You need to create standardized payment and billing methods that support good cash flow and stick to them. If that means saying no to some customers then so be it. Believe me, in the long run, you will be better off. 

 

Accounts payable policies

 

Your next consideration should be accounts payable or how you pay bills. When I am considering working with a new vendor one of the first things I ask is if they accept credit cards on autopay. Why? 

1. It doesn't affect cash.

2. It doesn't require any time or labor, meaning it can be fully automated.

 

Putting bills on autopay reduces your time involved with managing bills and helps promote positive cash flow.

 

I often see people advise businesses to cancel all bills on autopay. Believe me, I get it. They are right you are managing your cash flow. But you are wasting a lot of time doing so. Having bills on autopay still puts your payables out 4-6 weeks depending on your credit card cycle. Otherwise, you are just wasting time managing bills rather than focusing on your business and making money.

Occasionally, you will run into a vendor that you "have to work with" that does not accept credit card payments. You have two choices: don't work with them or find another payment solution. 

My next solution would be to allow them to automatically debit our checking account (although I hate this because it affects cash). If I do this, I set up a recurring charge to post in QuickBooks automatically so it posts to my cash balance before it even hits my bank account. That is called managing your cash.

The next alternative is to set up an autopay through your bank to go out electronically. Again, this is not ideal but sometimes you do have to make exceptions. One of the common scenarios you will face is your rent payment to your landlord or mortgage payment to your bank.

Now that you understand the type of system that promotes cash flow management lets move on to the next step.

 

Analysis of transactions that affect cash in advance

 

There are certain transactions that occur in your business that will directly affect your cash flow balance. Some common examples are rent or mortgage payments, payroll, or any of those annoying vendors that refuse to accept credit cards.

For any transactions that affect cash you need to post them to your accounting file well in advance, ideally 10 days or more. 

Here are a few examples of how to manage these transactions:

 

Rent or mortgage

 

When you have a rent payment to a landlord or a mortgage payment to a bank you often have a fixed payment on a specific date each month. You can set up a recurring payment in QuickBooks to post this amount in advance. That way you will be looking at not only your current bank balance, but also a bank balance in the future based on the upcoming payments.

Payroll - Any good payroll provider like Gusto or Rippling has general ledger import capabilities into QuickBooks Online. As soon as you process payroll you should post your payroll data to QuickBooks to see and manage how it affects cash. 

 

Regularly scheduled updates to your accounting system

 

This is probably the most critical and ignored step in managing cash flow. If you want to get a handle on cash flow, you need to design the right bookkeeping system (as described above) and update it regularly.

So how often do you need to update it? In all honesty, I update my books every single morning. I understand many business owners don't have the skill nor desire to do this. However, it gives me complete control over my books and cash flow.

There are a few critical things you can do to update your bookkeeping system regularly and effectively.

1. Maintain a regular cadence of updating your books. I suggest weekly. However, at the very least update the books twice a month. The 15th and last day of the month would be a great strategy.

2. Always updates your books on the last day of the month or the first day of the month. You don't want to wait until the 5th, 10th, or 20th to understand how your month went. You want to know instantly and be using that information to develop a strategy on how to move forward. More to come on this later on when we talk about forecasting. 

 

Analysis of cash flow shortages and overages

 

Ok, you have set up the correct AR and AP procedures and policies and are even posting your transactions that affect cash in advance. Now what? What has all this hard work been for?

Now you should be able to identify both cash flow shortages and overages. 

Let's start with the fun scenario of excess cash. What happens if you find yourself with extra cash. 

You can:

1. Save some for a cash flow crunch.

2. Pay down debt.

3. Invest in your business through a marketing campaign, inventory purchase, new hire, or piece of equipment.

4. Take an owner draw!

Unfortunately, you are also going to be able to see times of cash flow shortages. You will start to be able to run if-then scenarios. If I hire a new person at $80,000 salary per year, I will have a cash flow shortage for 3 months, but then I will get a positive return on my investment, increase sales by 20%, and get back to profitability.

Take a look at a cash flow management app called Dryrun to help you run these scenarios. 

If you do spot a cash flow shortage, where does the money come from?

 

Structuring your business for the ability to access cash

 

Line of credit

 

There are certain fundamental business lessons you only learn through mistakes and ignoring good business advice. 

I bet at some point in your career as a business owner that someone has given you the advice to maintain a good working relationship with your banker and always have a line of credit. Am I correct? If so, that is because that is really solid advice. 

The first thing I would do as a business owner that is growing is to establish a line of credit with my bank and use it. The question that I get asked is always: how big of a line of credit? The answer is, as big as they will provide. That is because banks are very conservative and will only give you a line of credit for what they think you can cover. 

A line of credit is the best way to access cash quickly to cover short-term cash flow shortages. You should regularly use your line of credit (at least quarterly) even if you don't need it. Banks don't like it when you have a line of credit and don't use it. So use it even if you don't need it, just to keep your credit going with the bank. When you do need to access your line of credit you will be glad that you followed my advice. 

 

Savings

 

I'm a saver by nature. Maybe being an accountant makes me conservative by nature. However, having cash on hand gives me peace of mind. It also gives me confidence in the tumultuous times to move the business forward effectively.

There is no golden rule of thumb of how much savings you should have. However, I think most small businesses should aim to have 2-3 months worth of operating expenses in the bank. As you can see, from this study by JP Morgan, most small businesses have much less cash on hand than that. Pay attention to finding 3 which notes that the median small business holds 27 cash buffer days in reserve.

COVID hopefully taught business owners the value of having cash on hand in savings. This goes for both business and personal savings. 

In cash flow crunches you should rely on lines of credit, then business savings, then personal savings that can be injected through owner contributions.

 

Forecast sales, key expenses, and business investments

 

Now that you have a handle on your cash flow the next step is to forecast your sales and expenses. Yes, this can be difficult for many businesses.

However, if you look at your historical data you should be able to spot some patterns in sales data. Then you need to consider what is different today. 

Is there some major economic issue impacting sales (good or bad) like COVID? 

What investments have you made in the business recently that might cause sales to increase?

Now take your historical data and what you know about what is happening in your specific business to make an educated guess about how sales numbers will look over the next 3 to 4 months. 

Do the same thing for expenses.

Do you know you will be making some investments into marketing, equipment, or hiring new staff?

Put projections of those expenses into your forecast for the next 3 to 4 months.

Now take a look at your forecast for the next 3 to 4 months and specifically pay attention to the bottom line.

How does it look?

Do you need to make any adjustments to make you more comfortable with the next 3 to 4 months of business activity?

 

Analysis of the forecast and cash flow to develop a strategy

 

Now, let's bring it all together. First of all, a financial forecast and cash flow management system are two different things. A financial forecast is simply giving you a glimpse into how you think your business will perform in the future. Your cash flow is showing you if you will have enough cash to make it through the next few months.

Your forecast and cash flow management need to ebb and flow together. They are both living and breathing tools that are constantly in flux. Your job as a business owner is to manage them both to develop a strategy for the future of the business while ensuring you have enough cash to implement your plan. 

It's not easy. It requires the right system. It requires regular updates. It requires a commitment to a process. It is something you won't commit to until you see the value in it. 

 

Do you want to manage cash flow better in your business?

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