Cash flow is the lifeblood of any business, and cash flow problems are a major cause of failure for small businesses. Knowing how to avoid cash flow problems, and how to handle them effectively if they occur, can mean the difference between the ultimate success or failure of your small business.
The Vulnerability of Small Businesses to Cash Flow Problems
Small businesses, especially in their early years, are significantly more vulnerable to crippling cash flow problems than larger, well-established businesses. There are a number of reasons for this. When you’re first starting out, your small business may be operating on limited working capital and revenues. Then, as your business grows and you look to expand it, the investments you make in growing your business – such as adding employees – can temporarily reduce your profit margins. Often all it takes to cause a major cash flow crunch is one slow sales quarter or one large customer who suddenly becomes a slow payer.
Here are five key tips to help you avoid having cash flow problems threaten your small business.
1. Lease instead of Buying
You can conserve your business’ working capital right from the start by leasing, rather than buying, expensive business equipment. This can be an especially smart financial move in respect to equipment that you’re likely to have to replace every few years anyway, such as office computers. Laying out only a minimal amount of money to get your business up and running enables you to keep more cash in reserve to weather any potential cash flow shortages.
2. Expand at a Modest Pace
A lot of small businesses run into cash flow problems in their second or third year of operation because they’re trying to expand too quickly. You may have had a great first year in business, and be eyeing all the future success you see on the horizon. Anxious to move your business forward, you increase your operating expenses substantially by, for example, adding new locations or spending more on marketing. Unfortunately, just about the time you’re doing that, there’s a downturn in demand in the marketplace. Before you know it, your business is operating in the red and having severe cash flow problems.
The solution? – Carefully plan the growth of your small business, and make sure that you have more than enough money to fund any expansion moves before making them.
3. Develop Strong Relationships with Lenders
One of the main reasons that small businesses tend to have more cash flow problems than larger businesses is that it’s typically much easier for larger businesses to access credit when they need extra cash. The time to work on becoming great friends with your banker isn’t when you’re desperate for a $20,000 loan – it’s when you’re flush with cash and not in any financial need.
Make it a point to cultivate relationships with lenders before you need their help. Let them get to know your business. Share your plans for future growth, and ask for their advice. In any event, don’t wait till your business is in financial trouble before looking to get a loan to help you through. As soon as you see a possible cash crunch approaching, go talk with your lender about getting a short-term loan if necessary, or perhaps renegotiating existing debt.
4. Shorten Payment Terms with Customers
Just because “net 30 days” is kind of the traditional, default payment term for B2B invoices, that doesn’t mean that you have to operate that way. Most customers will abide by whatever time frame you put on your invoices, as long as it’s within reason. But in managing their own cash flow, they’re not likely to pay you earlier than you request. Give yourself a cash flow edge by making your standard payment terms “net 15 days” or “net 10 days”.
Owners and managers of other businesses are familiar with the tight cash flows new small businesses often face. If you just go to them and honestly explain that you need to speed up your accounts receivables, most will understand and be glad to help you out. It might be worth offering a slight discount for a quick payment.
5. Use a Factoring Company
Taking advantage of the services offered by a factoring company such as Interstate Capital can be an easy way to ensure steady cash flows. A factoring company buys your accounts receivables at a discount. You don’t get quite as much money as you would have collecting payment for the invoices yourself, but not having to worry with the whole process of collections may save you more money than you trade off by selling your invoices at a discount. Factoring companies can also be a big help in evaluating how much credit you should extend to individual customers.
The important thing for you to remember as a small business owner is that occasional cash flow problems are likely to occur, particularly in your first few years of operation. But with careful business planning and smart money management, you can easily and successfully navigate your way through potential cash flow crunches.
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