The Importance of Cash Flow Management for Small Business Success

July 3, 2023
The Profit Plot


Welcome back to The Profit Plot, a podcast where we help small business owners unlock the story behind their profitable business by unpacking one complex financial topic at a time. I am your host, Jeremy Millar.

Cash flow management is an absolutely critical aspect of running a successful business.

This may seem obvious at first: clearly, you need to ensure that you have sufficient funds to cover your expenses, invest in growth opportunities, and maintain financial stability. But effectively managing cash flow can be extremely difficult for many business owners. Especially if you don't have the tools or information you need to do it properly. Without monitoring the story behind your cashflow, you may find yourself in an uncomfortable, untenable position.

That's why, in today's episode, we'll discuss the importance of cash flow management for small businesses: what is it? What are the benefits of managing your cash well and the drawbacks of not being a good steward?

I believe that, by understanding and effectively managing your cash flow, you can avoid potential financial pitfalls and set your business on a path to success.

Stay with us as we explore what cash flow management is, why it's crucial for small businesses, key components of effective cash flow management, and share valuable tips and best practices to help you manage your cash flow efficiently.

As always, to kick off our discussion on cash flow management, I think it's important to define our terms. What is cash flow for a small business? And what does it mean to manage it effectively?

When thinking about cash flow in the context of business finance, we're typically referring to the movement of money in and out of your business—the literal flow of cash.

Of course, cash is generated from your business operations, investments, and financing activities. When you make a sale of your services, you receive cash! When you spend money on things like marketing or payroll, for example, cash leaves your business.

At its core, cash flow is the foundation of your business. The lifeblood of creating a functioning organization is money!

With that understanding, it's easy enough to conceptualize cash flow management as the process of monitoring, analyzing, and optimizing the movement of money within your business. It involves tracking cash inflows and outflows, identifying potential issues or bottlenecks, and implementing strategies to improve cash flow and ensure your financial stability.

Now it's important that we not conflate cash flow with profit. There is a vital difference between these two; while profit is the difference between your revenues and expenses, cash flow focuses on the all-encompassing movement of cash within your business.

Picture, for a moment, your business's profit and loss statement. It's a breakdown of income minus expenses. So, at the bottom of every P&L, you'll find the business's net profit (or loss). The P&L can only offer a partial picture of how cash moves within your business.

This is typically due to cash outflows that don't show up on your P&L: things like debt financing payments, shareholder distributions, or other activities represented on the Balance Sheet. These items are not deductible expenses to the business, but they're still cash outflows.

For that reason, your business may be profitable from a P&L perspective but still face cash flow issues.

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Small business ownership is unique. These businesses often have limited resources and face unique financial challenges, like inventory constraints, staffing challenges, and more. All of which have significant financial implications. There are plenty of reasons why cash flow management is crucial for success.

First, properly managing your cash flow helps to ensure that your business stays solvent. Solvency refers to your business's ability to meet its long-term financial obligations - things like debt payments and other financial commitments. By properly ensuring that your business stays cash flow positive, you're preventing insolvency and potential bankruptcy.

Second, maintaining financial stability is essential for the ongoing success of your small business. By managing your cash flow effectively, you can ensure that your business has the funds to cover operational expenses, pay employees, meet contractual obligations to provide services or products. Having the cash that you need available in the bank is imperative, especially during difficult times. If your business is flush with cash to draw from in difficult macroeconomic periods, like recessions or global pandemics, you'll be able to weather almost any storm.  

Finally, it's my opinion that cash flow management enables your business to grow and expand. You can use cash to invest in new product lines, marketing campaigns, or other initiatives that can drive your business's growth. A healthy cash flow also makes it easier to secure financing from lenders or attract investment from potential investors. Having the right amount of cash allows you to make decisions about the future from a place of security, rather than anxiety and scarcity.

Cash flow management is critical for small businesses, as it ensures solvency, maintains financial stability, and supports growth. It allows you, as the business owner, to be better equipped for facing difficult times and to make wise decisions.

Now, let's explore the key components of effective cash flow management together. I think that, by focusing on these components, you can take proactive steps to optimize your cash flow and ensure the financial success of your business.

First, you need a process for regularly monitoring your cash. Typically, this process starts with an excellent accounting foundation! When your data is clear, accurate, and informative, the story behind how your business handles its cash flow becomes clear.

Reviewing a statement of cash flows, profit and loss, and a balance sheet allows you to identify trends and patterns in your business's cash position. It's important to review these statements consistently; at the very least, you should be looking at your financial information quarterly. Reviewing these statements more often, like on a monthly basis, enables you to spot potential issues early on and make informed decisions about how to address them. Does your business encounter significantly more expenses in a particular month than in others? Are your sales higher depending on the season, resulting in more cash?

By studying the full financial picture that your business is painting, you can proactively work towards preventing problems, creating financial goals, and planning for growth. Excellent accounting is an important step in helping you fully understand the story behind your business. Without a significant grasp of the numbers, you'll be essentially flying blind.

I remember working with a business owner in the past who was concerned that his poor cashflow issues were due to mismanagement of his money in general. The business relied heavily on purchasing massive amounts of product, which required a large cash balance in the first place.

We studied their cash flow in-depth and found that their inventory purchasing practices weren't a problem and that their expenses were modest overall! Instead, the labor side of the business was inefficient and significantly ate into the profit margin of every project, which ultimately reduced their cash flow over time.

Going beyond just monitoring your cash flows, it's useful to look for ways to improve your cash position. If you find that your business is strapped for cash and needs to generate money quickly, you can improve cash inflows by implementing strategies like early payment discounts to customers, attempting to collect on overdue receivables, increasing your prices, and exploring new revenue streams.

If you find your business has excess cash, it may be time to consider ways to invest into the growth of your business. Is it a good time to expand, or maybe to simply distribute profits to the owners?

Now, as with tracking your cash inflows, tracking where cash goes is also beneficial. In managing your cash flow, you'll often find areas in which you can cut costs or improve efficiency.

We often encounter small business owners who collect subscriptions to various software platforms, fully intending to use them at the time. Sometimes, months or years go by while paying for a software that doesn't actually get utilized. It's costs like these that are inefficient uses of spending that can limit the amount of cash your business retains. For some businesses, it may be useful to negotiate better terms with suppliers, reduce inventory levels, or simply study if their expenses are being used productively.

Finally, planning for contingencies and emergencies is an important aspect of cash flow management. Many small business owners have learned this the hard way. Unforeseen events and financial challenges can significantly impact your business's cash flow. When economic conditions tighten, drastically change, or markets shift, it's important to have a plan for the worst.

By setting aside an emergency fund and creating contingency plans, you can ensure that your business is actually prepared to handle unexpected expenses or fluctuations in cash flow without having to worry.

These key components – monitoring and analyzing cash flow, improving cash inflows, managing and reducing outflows, and planning for the unexpected – are vital components of effectively managing your business's cash flow. Oftentimes, the business owners that are excellent at preserving and deploying their cash when necessary are the ones that are able to build the most prominent legacies.

Before we end today's episode, let me say this:

Cash flow management is difficult to do on your own. As we've discussed, effectively managing and monitoring your cash position as a business owner takes an excellent financial foundation. For that reason, you should seek advice from financial professionals. Consult with accountants, financial advisors, or a financial coach to gain insights and recommendations for optimizing your cash flow management practices.

For most entrepreneurs, this is not a task that you'll want to take on by yourself. Properly understanding your finances in general can be a massive unlock for growing a successful business, but it's not easy. You need someone who is dedicated to the success of your business. A third party that will help you understand the story behind the numbers.

This will allow you to significantly free up your time. You'll be left with only the need to make decisions, which becomes much easier when you have clear, concise, informative data.

Cash flow management is a critical aspect of running a successful small business. So, don't do it on your own.

And that brings us to the end of today's episode. I hope you found this discussion on the importance of cash flow management helpful!

Make sure that you're subscribed to the Profit Plot podcast on Spotify, Apple Podcasts, or wherever else you get your podcasts from. If you found today's episode particularly insightful, please share it with a small business owner in your life! I'd love for other entrepreneurs to be able to benefit from what we learned today. I believe the more knowledge we can share with one another, the better off we'll all be.

Join us again soon as we venture to unlock the financial story behind your profitable business. Looking forward to having you here with us next time, on the profit plot.

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Jeremy Millar
Written by:
Jeremy Millar

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