7 Ways to Improve Cash Flow and Reduce Risk
President Donald Trump famously said, “Cash is king.” Like him or not, he was onto something. Cash flow is the lifeblood of business and critical to growth. Business owners learn very quickly that it’s difficult to survive when cash outflow consistently exceeds cash inflow. Every business, especially startups, must closely monitor cash flow to prevent business disruption.
In the traditional manufacturing business cycle, you pay for materials, make your product, sell your product and, ideally, get paid in 30 days. For a service business with no materials, you pay your employees, bill clients and, ideally, get paid in 30 days. This is why you need cash flow. Most businesses have to pay expenses before they get paid by customers.
Planning is the key to preventing cash flow issues in the short-term and long-term. Problems typically arise because the business owner hasn’t calculated incoming revenue streams (when, from whom, and how much) and balanced that against their need to pay vendors, employees and others. Those who don’t carefully project cash flow for upcoming days, weeks, months and quarters create serious risk for their business.
There will always be cash flow ups and downs created by circumstances beyond your control. That’s normal business. The key is to set yourself up in a way that prevents your company from being impacted by normal fluctuations.
Here are tips that can help business owners improve and better manage cash flow while minimizing risk.
1) Float Payables
One short-term strategy for improving cash flow is to float payables. For example, if you’re paying vendors a total of $100,000 in 30 days, you can pick up $50,000 in cash flow by paying in 45 days. You would only float payables one time because the next step would be to go to 60 days, which would only create $30,000 in cash flow, and vendors will start calling to find out when they’re getting paid.
The decision to float payables is typically based on the vendor’s value to and relationship with your organization. You might choose to pay key vendors in 30 days and push off smaller ones for a little longer. But again, this is a short-term strategy.
2) Extend Payment Terms
You can try to extend payment terms if you have a good relationship with the supplier. For example, if you’re struggling to meet 30-day terms, you could approach the vendor and say that you’ll never miss a payment if terms are extended to 40 days. Many companies, particularly smaller businesses will live with the extra 10 days if it means they know they’ll get paid on time.
3) Offer Credit Card Payments
Allowing customers to pay by credit card is a great way to quickly boost cash flow. Process the payment today, have the money in the bank tomorrow. For recurring business, it removes the risk of non-collection. However, this comes at a cost. Credit card fees mean it will cost you 2.5-3 percent of each payment to get that money up front.
4) Take Discounts
If you’re in a solid financial position and have the ability to pay quickly, see if your suppliers will take discounts. For example, if you have 30-day terms, request a 2 percent discount if you pay within 10 days. Even if you have to borrow money to pay faster, it can turn into excellent ROI. We’ve seen businesses turn this into a profit center. They borrow on their credit line at 4 percent, take discounts of 2 percent, and turn it into 18 percent ROI.
5) Offer Discounts
This is a last resort that we rarely recommend. It might not seem like much to offer a 2 percent discount, but if your margin is 25 percent, you sacrifice almost 10 percent of your profits. Also, if you offer a discount once, customers tend to expect that discount every time. That said, it could help you immediately increase cash flow.
6) Open a Line of Credit
This is standard for most businesses. Keep in mind that the best time to borrow money is when you don’t need it. Set up a line of credit today so it’s there when you need it tomorrow, and not just for a rainy day. If your business takes off, you’ll need money to grow.
Suppose you get a huge order. If you can’t get extended terms from the supplier, how will you meet payroll? How will you pay other expenses? Unfortunately, you can’t always sell your way out of cash flow issues. Even a huge sale won’t immediately improve your cash flow unless you get paid upfront. Many businesses have imploded because they tried to grow too quickly. They didn’t have the systems in place or the cash flow to support a high rate of growth.
7) Have a Reserve
For individuals, the rule of thumb is to have enough money set aside to cover expenses for three to six months. Businesses need to be prepared when something goes wrong. Notice we said “when” not “if.” Whether it’s a natural disaster, a market crash or a terrorist attack, every business should have a plan B.
Again, the key to building and maintaining a healthy cash flow is careful planning. If you’re not sure how to estimate cash flow, speak with your accountant or business consultant.