The U.S. Chamber of Commerce reported that 82% of small businesses fail because of cash flow problems. That makes managing cash effectively a very important part of leading a company. However, cash flow strategies can be complicated, and they need to account for several kinds of risk.
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Here are seven tips to improve your process and support your business.
Also see the seven most profitable small business ideas for 2024.
Forecast Your Cash Flow
First, you should forecast cash flow if you aren’t doing so already. This will help you identify and address risk before it impacts your business. For example, your forecast might reveal a cash flow shortage in the fourth quarter. If you get that information in the second quarter, it becomes much easier to address.
The multinational accounting firm PwC has a four-step process businesses can follow to forecast cash flow.
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Decide how far into the future you want to forecast based on your goals.
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List all sources of income.
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List all outgoing expenses.
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Use the figures to work out a running cash flow for the time periods that interest you.
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Understand Key Areas of Cash Flow Risk
Creating a cash flow forecast is a great first step. But even the best-laid plans can go wrong — often through no fault of your own. That’s why you should also familiarize yourself with common risks in cash flow.
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Operational risk: This includes internal fraud, poorly optimized payment terms and other inefficiencies.
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Market condition risks: Global macro conditions can impact how consistently you receive payments and how easy it is to access backup liquidity when you need it. This can also happen within your industry specifically.
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Supply chain risks: Complex supply chains are only as strong as the individual suppliers they rely on. And humans make mistakes.
Prepare Backup Funding Now
The question becomes this: What can your business do to avoid those sources of cash flow risk? One idea is to prepare backup funding that you can access as needed. Doing so would give you a relatively easy way to plug the holes in your cash flow as they appear.
Maybe the simplest option is to open a business credit card or revolving credit line. Each gives you ongoing access to funds as long as you stay within your limits and pay everything back.
Without a source of backup funding, businesses must scramble to resolve sudden cash flow issues. It’s easier and much less stressful to set all of this up before you need it.
Optimize How Money Enters Your Business
By structuring your company’s incoming payments thoughtfully, you can minimize financial risk. For instance, if your forecast reveals a cash flow issue on Sept. 1, you might request that clients pay their bills by the end of August. That way, money comes into your business before you need it.
You can get paid faster by being more proactive about invoicing — like following up quickly when clients miss their payments. You may also want to zoom out and take a big-picture look at company finances as they relate to billing dates. If there’s room for optimization, it’ll only benefit your business.
Reconsider Spending
Another idea is to consider your spending plan in relation to the concept of cash flow. For example, you might have a large materials purchase scheduled for Aug. 10 and a client payment arriving on Aug. 15. Delaying your purchase for five days could be beneficial from a cash flow perspective.
If you need to change how your company spends, reach out to suppliers. They may be willing to alter your contract terms — especially if you can frame doing so as something that’s beneficial for them too.
Revamp Your Inventory Strategy
It’s also important to consider how inventory impacts cash flow. Each item you have in storage carries a cash value that you can’t spend. That means the more extra inventory you have, the more challenging cash flow management can become.
If you already have extra inventory, you may not be able to do anything about it. But try not to accept deliveries like that in the future. To do this, you may need to change some language in your supplier contracts.
Maintain a Reasonable Amount of Cash Reserves
Finally, don’t neglect the importance of cash reserves. Having a reserve of cash makes it much easier to deal with unexpected risks as they emerge.
The general rule is to set aside three to six months’ worth of operating expenses. But consider your company’s needs when deciding. You may also want to think about the pros and cons of cash reserves versus credit.
For example, holding six months’ worth of operating expenses in cash may be unrealistic for your business. An alternative would be to open a credit line that can cover three months’ worth of expenses if you need it. That way, you have to hold only three months’ worth of cash to manage risk.
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This article originally appeared on GOBankingRates.com: 7 Ways To Manage Cash Flow and Financial Risks in Your Business
