5 Laws for Healthy Cash Flow

December 15, 2011

A company needs cash to stay in business. A company needs cash to grow. A company needs cash to compete. A company can look good on paper, and yet not have enough cash to make it through the next month. Hence, the importance of balancing cash flow.

Remember, cash flow is the money your company has available so it can pay salaries, rent, expenses, payables and equipment. When you create a new invoice for a product or a service, it shows up in the books as an asset. However, the money isn't available yet. You can't pay for anything until the customer pays the accounts receivable.

These activities affect cash flow:

  • Customers slow to pay invoice.
  • Not enough or slow sales.
  • Standard expenses, such as payroll, rent and phone service.
  • Unexpected expenses, such as building repairs and replacing broken expensive equipment.
  • Charging too much or too little for products and services.
  • Failure to consider financing.

Simple example on how timing affects cash flow: a customer that pays you in 45 days affects your ability to pay your credit card bill that's due every 30 days. Since the customer is over two weeks late, you may be stuck paying a fee for missing the payment due date.

You can do many things to manage your cash flow, such as changing your the bill cycle for your credit card payment so you can pay at a different time of the month. The following five basic laws set the tone for better cash flow management.

1. Update and check financial reports often.

Do you have a cash flow statement? Do you have the necessary financial reports to help you make decisions? If not, work with an accountant or bookkeeper to create one, and then learn how to read and maintain the reports. If you don't have a full-time financial expert, you can hire one to work with you when needed.

2. Review accounts receivables.

How old are your accounts receivables? Do you have incentives in place to compel clients to pay on time? One way to do that is to have a clause in your contract that says you charge a fee for late payments or a discount for early payments. To get cash faster, you could sell your invoices to a private lender. The downside is that you won't get the full amount, but at least you get most of it.

3. Set prices based on what clients will pay.

Study competitors' rates and factor in the difference between what you and your competitor offer or lack. It may take practice and rejections before you find the magic number. If everyone agrees to your rates, it may be time to try increasing them.

4. Build a safety net.

Things break. Disasters happen. A business can suddenly encounter a big and unexpected expense. Be ready for anything with a crisis management plan and plenty of cash. If the day comes that you need the emergency stash, start building your cash reserves again.

5. Get financing.

Have you looked beyond banks for financing? You have microloans, credit unions, private or specialty lenders and other financing organizations. Not all of them are bound by same rules that banks must follow. This is especially true for companies that sell services as they often have little or no collateral that banks require.

Study your financials to identify when you're low and high on cash. It may take a few months of reporting before a pattern appears. This information will prove valuable in helping you find and maintain balance with your cash flow.

What tips do you have for managing cash flow? What reports tell the story of your business?