Cash flow is the lifeblood of every business. Without cash, it’s hard to purchase inventory, pay employees, and ultimately keep the doors open. In fact, according to PreferredCFO.com, 82% of small businesses fail because of poor cash flow management skills or a poor understanding of cash flow.
“While there are multiple factors to consider with cash flow depending on the industry and the lifecycle stage of your company, one key is relevant to all small businesses regardless of size or industry: If your expenses exceed your cash, then you have a cash flow problem,” writes Michael Flint.
Do You Know Your Cash Flow Metric?
If you’ve never heard of your cash flow metric before, it’s something you should get familiar with. Your cash flow (or working capital), as described by Flint above, is your current assets minus your current liabilities. Current assets being defined as things like your cash in the bank, your current Accounts Receivable, your inventory, your business location (if you own it), and any equipment or other assets you may have to facilitate doing business.
Your liabilities are usually defined as your current Accounts Payable and any long-term payables you might have. A business loan, line of credit, or other business debt would be included in this number.
If you divide the value of your current liabilities into your current assets, you’ll come up with a ratio of assets to liabilities. The ratio you’re shooting for should be to have twice as many assets as liabilities (or a 2:1 ratio).
Although this is difficult for many small business owners to achieve, any ratio below 1:1 indicates that it’s costing you more money to operate your business than you’re taking in and could be an indicator that there are real problems with your cash flow—even if you have cash in the bank at the end of the month.
How Should You Address a Cash Flow Problem?
Flint makes some suggestions, I really like, to address a cash flow challenge beyond simply generating more revenue:
- Categorize your spending: He writes, “Your first step should be to know exactly what you’re spending and where you’re spending it.” If you’re not sure of the best way to do this, your CPA or a capable bookkeeper should be able to help you determine the best way to categorize your business expenses. They will also be able to help you with some accepted rules of thumb for how much of your revenues should be devoted to categories like marketing, operations, sales expense, R&D, etc.
- Benchmark: “You should have a clear picture of how other businesses are spending and use those benchmarks to spend similarly,” advises Flint. “Consider businesses within your industry as well as businesses within your company’s lifecycle stage.” The idea isn’t necessarily to mimic what other businesses are doing, but to take the opportunity to get a feel for where you should be vs. where you are and determine what’s right for your business. Here’s another place where you can consult with your accountant. I’m a big fan of making that relationship less transactional and more consultative.
- Micromanage Your Spending: “Remember that every dollar you spend is detracting from your profit margin, so especially during the early stages, it’s important to consider the cost-benefit of every single expense,” argues Flint. I couldn’t agree more. Growing up in what I call a “small business family” watching my Dad run his business, and having spent most of my career of nearly 40 years either working in a small business or operating a small business, I’ve really come to appreciate that how and where you spend your cash flow has a big impact on the success of your business. Controlling your expenses is a powerful way to impact your bottom line.
If you’ve ever heard the phrase, “Cash flow is king,” it’s absolutely correct. Unfortunately, it feels like popular media would have you believe that cash is the solution to all the challenges a small business owner faces. I believe the creative problem is really the answer. I consider looking for ways to more creatively go over, around, under, or through a problem to be the answer to many of the challenges a small business owner faces—and that includes taking control cash flow.
Once you have your expenses categorized, an idea of where it makes sense for your business to spend its valuable resources, and have tight controls on spending, you can make better-informed decisions regarding where and when to invest in growth initiatives, when borrowing could make sense, or when to simply stay the course.