Cash flow is basically what describes what comes in and comes out of a business treasury, such as income from sales and/or bill payments. Its’ importance lies in the fact that it allows us to quickly know the liquidity of a business, giving us key information that helps us make better decisions.
However, as business expands, it will need more money to keep it growing. As your income increases, so will your costs, and the profits from your first sales are likely not enough to finance this initial growth spur. Getting your brand known and reaching sales volume takes an average of 6 months, so you’ll need to have capital before you start to see sales revenue. In this first stage of growth, it is essential to have an orderly and methodical control of your cash flow.
A 2017 Fifth/Third Bank survey of 505 employees in private organizations with less than $ 10 million in revenue found that 32% of business owners consider lack of funds to be one of the main obstacles to growth.
This means that if a business is growing, but cash flow is not managed effectively, the venture may not operate, much less prosper and be successful over time.
3 Ways To Improve Liquidity & Generate Higher Profits
Thinking about how you can improve cash flow while growing a business is one of the biggest concerns for departing business owners and managers. The good news is that even though a business can grow rapidly, it can improve its cash flow. Traditionally obtaining financing is the main alternative for many entrepreneurs. Today it is possible to obtain capital through new investors, request lines of credit, crowdfunding or use accounts receivable factoring. However, there are other ways to improve the cash flow in a business, including some approaches that may seem unconventional.
Have a conversation with your clients/customers
Although using factoring is an excellent alternative to obtaining immediate financing, there is another option that few managers and entrepreneurs take into account: talk honestly with your customers.
It sounds logical and straightforward, but many business owners and leaders fail to see the advantage. If they owe you money, you will have problems with your cash flow, and therefore, you probably also owe money to your suppliers or have unpaid bills. Typically, in new businesses, doubling revenue also doubles costs, but the time to handle the workload stays the same. The situation becomes worse when customers go beyond the payment terms of 30, 60, and 90 days. To reverse this and improve your cash flow, a practical option is to talk to the suppliers or whoever money is owed to see the possibility of paying them when they pay you. This is an example that communication is essential when maintaining solid relationships with suppliers.
As time goes by and there are continued liquidity problems, it is likely that the prices for products or services are not set correctly, or profit margins are too low. For example, if you are spending a lot on salaries, rent, advertising or infrastructure but have little to no profit left over, you should evaluate if the price you are charging is correct.
Profitability has a direct relationship to liquidity; if your prices are not set to the desired profitability and the numbers to calculate that are not clear or accurate, then liquidity problems will persist. Many times, business leaders fail to review pricing regularly to include profit margin goals and how to cover costs like overhead. Some companies go for years before they adjust pricing or even raise pricing. Understanding the market and building the value proposition is vital to have the confidence to raise pricing. Most entrepreneurs worry that a price increase will result in losing existing customers or market share. However, the price increase must be well thought out and accompanied by strategic objectives. For example, if prices are eventually increased, you may accompany it with a marketing campaign that can offer a royalty program to existing customers, so they do not receive the news so abruptly. In the current environment and economic situation, we are in, raising prices is probably expected by the market.
Determine the problem:
It might be that the problem is not really in what comes in and goes out of the business treasury, but it may be in other external factors such as not accurately forecasting how the market is expected to change in the coming months, or even taking a long time to finalize contracts with new clients or lead times are too long from receiving/producing to invoicing, for example. Producing and measuring cash flow reports regularly is another good practice. If it is done continuously, it will allow, for example, visibility on possible negative balances concentrated on a certain day of the week. In this way, you will have better understanding of the movements and fluctuations of cash, so it will be easier to find a solution in the coming periods and forecast cash needs. It is also advisable to review the operational cash flow cycle at least once a month, updating the values and assumptions each time is produced.
Lastly, when recording income, list separately as line item on the cash flow or cash management platform, checks and promises of payment, since it is money that does not yet physically exist, it is preferable to list separately since it is not a certainty that you may be collecting it. The best practice in these cases is to include a calculation of expected future income.
Cash flow is one of the best tools in any investment project. However, when your business grows, keeping your finances in order can be complex. The information that cash flow provides, from even the basic aspects that each business must consider to less traditional ones, as mentioned above, are essential metrics to make future strategic decisions that lead to healthy business growth.