Managing Cash Flow: An In-Depth Guide for Entrepreneurs

Ever heard the phrase, “You’ve got to spend money to make money?” Without money to invest back into it, your business won’t be able to grow and flourish. Understanding and managing cash flow is crucial for entrepreneurs working to create a successful business at any size. In this in-depth guide, we’ll cover everything you need to know about the basics of cash flow, from the different types of cash flow, what’s in a cash flow statement, the difference between cash flow and revenue, and actionable ideas for improving your business's cash flow now. What is cash flow? Simply put, cash flow is the money that your business is making and spending. It’s the money that flows in and out of your business. When your business has money coming in, and that cash is more than you’re spending, that’s a period of positive cash flow. Of course, keeping cash flowing smoothly is the goal of every business. But even highly profitable businesses tend to have their ups and downs—and understanding how to ride the wave of negative cash flow can help keep a business afloat. Positive cash flow Let’s say your landscaping business just received the payment for a pricey contract. Your salaries have been paid for the month, you don’t need to buy any new materials, and you’ve got no outstanding debts. Right now, your business is experiencing a positive cash flow. Negative cash flow Next month, you place a major order for some expensive new equipment you’ll need for an upcoming contract. The order turns out to cost a lot more than you had planned for. Plus, you end up having to pay one of your employees’ overtime after a job that dragged on way longer than expected. This month, you’ve spent more money than you brought in, and that’s negative cash flow. While this negative cash flow may just be a temporary problem, it could have major impacts on your small business: you might not be able to pay your employees, leading to them finding other jobs. Or you might not be able to purchase new supplies needed, which means your upcoming contracts can’t be completed. Net cash flow The difference between the money you’re receiving and the money you’re spending during a certain period is the net cash flow of your business. Although they sound pretty similar, net cash flow isn’t quite the same thing as net income. Non-cash expenses (for example, depreciation) are included in a business's net income calculation but don’t impact net cash flow. At the end of the day, net income is the bottom line profit of your business, and a positive cash flow may not always equal a positive net income. The 3 types of cash flow Beyond just negative and positive, we can also define cash flow as belonging to one of these three categories: operating cash flow, investing cash flow, and financing cash flow. Operating cash flow This tends to be the most important type of cash flow for entrepreneurs. Operating cash flow simply describes the money that your business makes and spends during regular, everyday operations. Maybe you’ve recently launched a successful new business: your food truck dishing out delicious burritos has become everyone’s favourite downtown spot for a cheap and cheerful lunch. Your operating cash flow for one month might include the following items, just to name a few: Cash received from food salesWages for your burrito cook and cashierMaintenance and repair costs for your kitchen equipmentPurchase of gas for the truckPurchase of supplies such as beans, tortillas, and all the secret spices that make your burritos so much tastier than the competitionInsurance feesAdvertising costs This gives us a snapshot of the sort of costs and income that make up the operating cash flow for a small business. A solid understanding of what goes into your operating cash flow and whether positive or negative cash flow is the result can help you better understand how well your business is performing. Investing cash flow Investing cash flow is money that comes from investments. These could be properties your business owns, market securities (stocks and bonds), and equipment, among other things. Not all small businesses will have this type of cash flow—it is more common for larger businesses or those in industries that tend to involve purchasing and selling property or equipment. Financing cash flow When a business has investors, the money will flow from them to the business and back again. So financing cash flow refers to the movement of money between the owners and investors of a company. If your business doesn’t have investors, it won’t have this type of cash flow. A large business may have a complex ownership structure with many investors and might significantly finance cash flow. Why cash flow is so important for entrepreneurs Cash flow problems are a common struggle for entrepreneurs with brand new businesses. When you’re just beginning to ramp up sales and build customer relationships, it can be especially difficult to ensure you have enough receivables coming in to cover all your payables. But even established, highly profitable businesses can also experience negative cash flow due to unexpected bills or mismanaged money. That’s why a solid understanding of how to manage cash flow is crucial for every entrepreneur. What businesses are most impacted by cash flow issues? New businesses Cash flow management is particularly important for new businesses and growing start-ups. When a business is in its early stages, a lot of big expenses tend to come up. Expanding business means hiring more employees, buying more inventory, investing in new equipment, maybe acquiring new property—and all this expansion requires cash flow. At the same time, a new business is still a growing business. That means costs can all too easily outpace cash coming in. Cash flow analysis, which we’ll discuss below, helps new businesses better understand and deal with these sorts of cash flow challenges. Seasonal businesses Businesses with busy seasons followed by slow periods are more likely to be impacted by cash flow troubles. Any business that involves outdoor work will experience some major weather-related ups and downs, as will businesses offering goods or services related to holidays (such as florists, event venues, cake bakers) or travel. It’s particularly crucial for seasonal businesses to keep their cash flow well-managed. Creating a sales forecast can be helpful in staying on top of seasonal cash flow changes. Small businesses Small businesses, in general, tend to have less cash, or even no cash at all, coming in from financing and investing activities. This means that operating cash flow needs to be managed particularly carefully to prevent business failure or the need for frequent loans. Cash flow and revenue: what’s the difference? Cash flow and revenue are both important measures of how well a business is operating. While cash flow refers to all the money coming in and out of business, revenue is just the money a business earns, such as sales of services or products. Net cash flow may be negative or positive, depending on a business'ss liquidity in a given time period. A business could have a negative cash flow in a quarter with skyrocketing sales due to poor operational management. Increasing revenue shows how successful a business is in sales and marketing, but this revenue might not necessarily mean positive cash flow. How revenue is different from profit Revenue isn’t only sales, although the two words are often used to mean the same thing. It can also include other income, for example, money earned through investments. Similarly, profit and revenue sometimes get mixed up. Profit is what results when you subtract all your costs from your business revenue. Just as a business might have increased revenues and negative cash flow, a business can also have steady revenue coming in and still not make a profit due to high operating costs. Profit and revenue are valuable metrics to consider when evaluating the health of your business. At the same time, a cash flow analysis is also a useful tool to help you to better understand how your business is performing, enabling you to better make decisions about when and how much you can expand. What’s in a cash flow statement? A cash flow statement is simply a record of the money that went in and out of your business during a specific time frame. Comparing the monthly, quarterly, and yearly cash flow statements for your small business can offer an overview of how well your business is operating and give you better insight into changes in net cash flow over time. A cash flow statement is also the most reliable way to see how much money you actually have at hand in a given month. Your income sheet may show a lot of money coming in—but your cash flow statement will show whether or not that money is available to be spent. How to read a cash flow statement Cash flow analysis is important not just because a cash flow statement helps you measure business performance and assess your current liquidity. You can also use your cash flow statement to predict future cash flow, which can help you plan better for the future of your business. Cash flow statements will vary a lot, depending on how many sources of income and expenses a business has. But in general, cash flow statements will include the following elements: IncomeOperating cash flowInvesting cash flowFinancing cash flowNet cash flow The cash flow statement will include a breakdown of additions and subtractions to your business's cash flow, with the final result being your net cash flow for the month. For many entrepreneurs, the operating cash flow tends to be the part of the cash flow statement that’s most useful in understanding how well the day-to-day finances of your business are doing. Actionable tips for cash flow management These pointers for managing and improving cash flow can offer some helpful options even when business isn’t booming. We’re focusing on how to improve operating cash flow here because this tends to be the most valuable for small businesses. Issue invoices right away Stay on top of your receivables by issuing invoices promptly, with clear timelines for payment. Be sure to follow up on unpaid invoices right away as well to help keep the cash coming in. Ensuring that the instructions for payment on your invoices are clear and easy to understand is also crucial. Include a prominent due date of payment as well as an itemized list of goods and services, so your client knows exactly what they’re paying for and when. Keep inventory up-to-date Be sure to get rid of any dead stock inventory you have taking up storage space by selling it at a discount or even returning it to the producer, if possible. It might be hard to remove a product you personally like from your store or cut a personal favourite dish from your restaurant’s menu. But if it’s not getting that cash flowing, it’s probably time to say goodbye. Keep in mind that if you often find yourself with products that stay on the shelf a little too long, you may want to do a more careful evaluation of your buying and marketing strategy with an eye to improving future cash flow. Encourage early payment with discounts Reward your best customers and stay on top of your cash flow management by offering discounts for early payment. This allows you to demonstrate that you appreciate the good relationships you’ve built with reliable customers while also encouraging those customers to remain reliable with payments in the future. Plan to avoid late-paying customers A serious source of cash flow trouble can be caused by customers who don’t pay on time—or worse, don’t pay at all. You can be proactive in trying to avoid this unfortunate occurrence through a few different measures. The most obvious one, which many small businesses implement, is to request an up-front cash deposit for orders. Another similar option that can help you avoid the negative impact of customers who consistently pay late is to request cash on delivery, requiring payment as soon as the job is finished or the product is delivered. Pay on time, but not too early We’ve covered a few simple ideas that may help improve your operating cash flow by better managing your receivables. But effective management of your payables can also be an effective tool to keep that cash flow positive. One way to optimize your bill payment to improve cash flow is to pay bills on the last day they are due. For example, if you have a regular bill on the last day of the month, schedule an automated payment to transfer it on that last day. This allows you to keep more cash at hand longer while still ensuring your suppliers are happy. Reschedule payments to suit your schedule Having too many bills due at the same time of the month can make payment difficult and cause cash flow issues. Building up strong relationships with vendors can allow a business to request reschedule payment times to manage cash flow better. In addition to arranging alternate payment dates that allow your business to stay on top of payables, you can also consider switching some monthly payments to yearly or twice-yearly when possible. In some cases, you might even save money with a yearly subscription to a service. If month-to-month cash flow is negatively impacted by too many payables, choosing to pay some bills once yearly could be a big help. Make thorough price comparisons While it might be easy to assume that the lowest price is always the best bet for savings, a lower price doesn’t always mean better cash flow. A vendor who offers a flexible payment plan over time might be a better option for your small business than one who can sell you the same supplies for cheap but needs the full payment upfront. Sure, you might save some with the lower price, but if cash flow is a concern, it may not be worth it. Temporary solutions for quick cash flow fixes Serious cash flow challenges can mean having to make the tough decision of which debts to pay first or choosing between paying debts or payroll on time. No entrepreneur wants to be in that position—not only is it bad for a business, it’s also a pretty stressful experience for the people working there. Fortunately, there are a few tried-and-true temporary solutions for cash flow issues that businesses may find helpful. Take out a line of credit If you don’t already have one, taking out a business line of credit is one simple option to help boost cash flow. You will need to have a decent business credit score: if you’ve registered your business and been paying bills and invoices on time, you may be able to get a line of credit for your business which will offer a quick cash infusion. Be sure to do the research to determine which line of credit is best for you and offers the lowest interest rate. Consider fees, the rate of monthly repayment, and also whether or not you want a secured or unsecured line of credit. Get a small business loan Obtaining a loan is another way to boost cash flow to your small business during a particularly tight time. There are several ways to get loans for your small business in Canada. Short-term bank loans are a fast way to improve cash flow for those times when you need to cover operating costs right away. As with a line of credit, do the research and get informed about the best interest rate beforehand. Another financing option to look into is the Canada Small Business Financing Loan, which is a government loan program for small businesses and start-ups wanting to improve or expand their assets. Although there are restrictions on what this loan can be used for, it may be helpful depending on your individual business needs. If you’re in urgent need of cash flow to do renovations, purchase equipment or vehicles or buy commercial property, consider looking into this loan. Consider a small business grant There are many different small business grants that Canadian businesses can apply to cover costs such as training and hiring new employees, research and development, and much more. If you’re located in Ontario, this list of small business grants in Ontario covers quite a few options. Some grants may take a while to apply for and receive, so this option isn’t as speedy as a bank loan or line of credit. But given that grants are typically funds you don’t have to repay, the extra effort of applying for a grant may be worth it for the good of your future cash flow.