Are cash flow problems keeping your business from thriving? If you don’t fully understand (or effectively monitor) your cash flow, you may be inadvertently sabotaging your business. Without a good system in place, you’re putting yourself at risk for a number of potentially destructive financial problems.
Effective cash flow management begins with recognising potential problems that could significantly impact your business.
Here are five common cash flow mistakes to avoid from Entrepreneur:
1) Overestimating future sales volumes
Relentless optimism is a key trait of successful entrepreneurs. After all, what realistic person would persevere in the face of so many obstacles, so many naysayers and so much stress? But while optimism is critical for a new business owner, letting it compromise your objectivity can be dangerous to your cash flow.
Unfortunately, not every interested looker will actually make a purchase. While your sales volumes may increase over the holidays, expecting them to double is a little unrealistic.
That’s why it’s so important to complete objective and realistic sales forecasting based on historical evidence and real numbers. By applying quantitative forecasting methods, you can use actual past revenue data from your own business or other businesses in your industry as a basis for tracking trends and predicting future sales. This information, along with some objective intuition, will help you come up with more realistic future sales projections.
Revenue forecasting can be especially difficult in your first few years of business because you don’t have past sales figures or as much experience to draw from. This is where working with a mentor from within your own industry may be extremely useful. A good business mentor can offer his or her own experience to help you project future sales, and even offer historical sales figures from personal experience to help you predict upcoming sales volumes.
No matter which method you select, make sure to base your future sales expectations on objective facts and sound judgment. This will save you from overspending based on pipe dreams that may never come true.
2) Engaging in impulse spending during the startup phase
“It takes money to make money”: We hear this saying so often in business, and in many ways it is true. But, unfortunately, this common belief can make many a rookie entrepreneur fall prey to gross overspending — especially in the first few months of business.
The reality is that while, yes, it does take money to make money, not all startup expenses are created equal. Starting a business involves plenty of clearly beneficial expenses — costs that will benefit your company’s profitability in measurable ways. But there are also plenty of consultants, advisors and B2B service providers who would be happy to take your startup’s capital for things you don’t actually need.
If you want your business to make money, then, keep your eye on the bottom line, considering the cost-benefit of every single expense. After all, every dollar you spend on your business is a dollar that is ultimately taken away from your profit margin.
Along with your revenue forecast, create a realistic budget, and stick to it. Calculate when you plan for your business to break even — and as unexpected expenses or opportunities for impulse spending come up, go back to your projections and calculate how those purchases will delay your break-even point. You may decide that your employees don’t need that ping pong table after all.
3) Being passive about past-due receivables
One of the fastest cash-flow killers — particularly for small B2B businesses — results from unpaid invoices from clients. If you aren’t being proactive about collecting payments from your clients, you could be on your way to a dangerous cash-flow situation.
Sadly, small businesses that don’t have solid late-payment penalties and collections policies in place are often taken advantage of. If your clients don’t know for sure that they’ll hear from you the moment a payment is late, you’re sure to be the last of their vendors to get paid.
If you haven’t already, set clear policies with your customers for penalties and consequences when payments are late. Good policies include a 5 percent late penalty after five days, and work stoppage after 30 days past due (for service-based companies).
Create an internal time line of procedures for when you’ll send the initial invoice, when payment reminders will go out and when you’ll make collections phone calls or cut off services if past invoices aren’t paid.
Some companies have even benefited from incentivizing customers through discounts for early payments.
4) Not using a cash-flow budget
So, say you’ve set realistic expectations for future sales. You’ve reined in spending, and you’re doing everything possible to make your clients pay up. These three changes alone will do wonders for your company’s long-term cash flow. But without tracking your day-to-day cash flow, you may still find your business in a tight spot.
For retail companies, the months just before the holidays are a time when cash flow can be particularly tight. You need more inventory from your suppliers to prepare for an influx of sales, but if those supplier payments come due before your sales actually happen, you may have trouble paying bills on time.
Using a cash-flow statement will help you track your inflow of revenue and outflow of expenses during a specific time period. This will help you anticipate when you’ll have more money going out than coming in, so you can plan ahead for those difficult periods. Without one, you’re just guessing at whether you’ll have the money you need when you need it, and you’ll increase your chances of facing late payments and other penalties on past due invoices.
5) Not keeping a cushion of cash on hand
No matter how many safeguards you have in place to protect your company’s cash, hiccups in cash flow are a business reality. This may be no big deal if you have a cushion of savings on hand. But if your company is working from a zero account balance, one slow sales month could mean instant disaster.
To safeguard your business from cash-flow issues, maintain an account balance equivalent to at least two months of operating expenses. That way, even if you experience unexpected stalls to cash flow, you have reserves in place to protect yourself.
Cash-flow issues are one of the greatest challenges of business ownership. But if you stay objective about your business, rein in unnecessary spending and stay alert to potential pitfalls, you’ll be head and shoulders above your business peers in your potential for long-term business success.
If you’re making any of these common mistakes, try to start rectifying it today.
For more business advice, head to Entrepreneur.com.