If you’re like most people starting a new business, you’re short on cash and long on advice. And most of the advice probably has to do with the cash. Particularly, be careful with it. Cash flow is such a hot topic among entrepreneurs there are entire categories devoted to it on sites such as Open Forum and Entrepreneur. But for all the jabbering, most small business owners I talk to are still pretty vague on what cash flow actually is ⎯ and, more important, why it matters. Don’t worry; it’s not complicated. But it will probably make the difference between your business staying afloat or going under.
Here’s what you need to know.
- Cash Flow Is Not Profit
Your company can be hauling in profit by the bucketload and bleeding out cash at the same time. Keeping your company afloat comes down to more than just profits and losses; it’s also about timing. And that is where cash flow comes in. Cash flow is the amount of actual cash you have on hand during a given period of time. The official definition is: “The difference between available cash at the beginning of an accounting period and that at the end of the period.”
Let’s say you buy a piece of inventory for $10. Profit/loss-wise, you haven’t gained or lost anything. Cash flow-wise, you’re out $10.
Later, when you sell that piece of inventory for $15, your profit is +$5, but your cash flow is +$15.
But let’s take it a little further. Say your customer bought the item on credit or that you’re going to invoice them later. Now your profits are still $15, but your cash flow is -$10. At least until they pay up. And that’s how you can be profitable and broke at the exact same time.
Profits are about big picture net income. Cash flow is about what’s in your account right the heck now.
- Cash Flow Is Super Super Super Important
It’s not enough to have a profitable company. You need to be cash flow positive if your company is going to stick around long enough to impress your dad. A lot of profitable businesses die simply because they couldn’t manage their cash flow. It’s so common the Global Banking Institution put it on its official list of things for entrepreneurs to keep in mind: “Many businesses fail due to lack of cash, not lack of profits.” Don’t give banks the satisfaction of being right about something for once.
- You Can Be Cash Flow Negative for a Minute Without Having a Panic Attack
Hey, look. It happens. And it’s honestly pretty common early on when a lot of your money is going out and not enough time has passed for money to start coming back in. This is especially true for companies that rely on invoicing. There can be a long gap between items sold or services rendered, and a check received (especially if the person you’re invoicing is cash flow savvy … more on that below). So if you’re just getting started or you hit a bumpy month or two, don’t panic. The cash flows both ways. If your checks are clearing, you’re in the clear. Just make sure you have enough cushion in the bank to get you through (more on that below too.)
- Managing Cash Flow Isn’t That Hard
For all the fear-mongering, managing cash flow really isn’t that complicated. Here are some things you can do to stay on top of yours:
Stay organized: Keep consistent records of the cash (not the profits) that is coming in and the cash (not the losses) that’s going out. You can also use this calculator from the good folks over at Entrepreneur magazine. It’s not pretty, but it’ll get the job done.
Invoice fast, pay slowly: Here’s one of the oldest cash flow tricks in the book. Invoice quickly (and encourage your clients to pay quickly through early payment discounts and short payment terms), and then take your time paying the invoices people send to you. In other words: Do not do unto your neighbor as you would have them do unto you. Smart business owners know that keeping their cash for as long as possible is one of the most important things they can do to stay cash flow positive ⎯ much more important than paying invoices in a timely manner.
Keep enough cash on hand: The rule of thumb for a good night’s sleep is to have at least enough cash on hand to cover operating expenses for three months. Six months if you’re a worrier.
Open a line of credit: Nothing can prepare you for every circumstance. Bad seasons come. Major clients don’t pay. But hey, that’s what lines of credit are for. It’s pretty easy to open one with your bank after you’ve been in business for 24 months. And most banks will give you a line of credit equal to 10% of your gross yearly revenue at a relatively low interest rate, which should be plenty to get you through even the worst months. As soon as this becomes an option, take it. It’s free peace of mind.
The one thing guaranteed to kill your cash flow is putting off sending invoices, which a lot of small businesses do because 1) they’re busy and 2) invoicing is tedious. We can’t solve all your cash flow problems, but fixing your invoicing is right up our alley. Our app makes invoicing fast and easy; keeps track of what’s coming in and going out; and with our Stripe integration, your customers can pay with a credit card (aka: instant cash). Try it out for free and see what you think.