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What to do when you have an abundance of cash flow
Sales are through the roof. Your investments are paying off. You have too many clients and not enough time. While these may be slight exaggerations, if your business is booming, we need to talk. It’s important to talk about when cash is tight, but what about when your business is thriving?
Being an entrepreneur isn’t all famine. There are times when we feast, too. And while it’s easy to get caught up in the extra funds and splurge on an impulse purchase, there are more responsible—and ROI-driven—ways to use that cash inflow. Let’s take a look:
What to do when you have surplus cash flow
Figure out why you have excess capital with a cash flow analysis
First and foremost, you’ll want to validate that you do, in fact, have excess cash flow—and then determine why that’s the case. It’s important to make sure your figures are correct because if you spend money you don’t have, you could find yourself in a real pickle. And once you’ve validated your accounts via a cash flow analysis, learning why you have extra cash on hand can help you optimize those income streams and further increase your cash flow.
Many entrepreneurs are familiar with the ebbs and flows of business finances, so learning why it fluctuates gives you more insight into maximizing your profits.
“I would want to know if it’s a one-time increase in cash flows, some extraordinary event, or a windfall,” says Ken Stalcup, CPA, CFE, CFF, ABV at Houlihan Valuation Advisors.
A cash flow analysis and full review of your financials can help you discover and predict times of surplus.
“Look at your working capital needs over a full year period,” says Lou Haverty, CFA at Financial Analyst Insider. “There may be normal business-related or even seasonal factors that influence your working capital needs during the year.”
Have a seasonal business? Learn 5 ways to improve your business during slow seasons.
Build a cash buffer
We’ve discussed this previously, but it’s significant enough to reiterate: 30% of businesses fail because they run out of money. Failing to pay attention to your cash flow can make you vulnerable to this risk.
That’s where a cash buffer comes in. A cash buffer is essentially a financial safety net which protects you and your business in case of emergency. This is money you set aside for times when you really need it.
When you have an abundance of cash flow, it’s always a good idea to look at your cash buffer.
Chris Roane’s experience running Point of Hue Salon has taught him the importance of a cash buffer.
“Having a very large business emergency fund is vital for handling unexpected business expenses, filling in gaps in cash flow when business is slow, and being able to use funds to expand the business,” he says.
One example is a $12,000 tax bill. Without a buffer, this could’ve been crippling to the business.
“We would have either had to make payments or go into debt,” Roane says.
Invest in passive income strategies
Passive income strategies are great because it doesn’t require any active input from you. Service-based businesses, for example, rely on the service provider’s time and effort to provide said service. If you don’t have the time to provide the services, you have no way of generating revenue.
Plus, passive income takes the pressure off your other income streams. Maybe you have a business with seasonal highs and lows, and passive income can help you even out cash flow during those slow times.
Want to integrate passive income strategies into your business? Read more about 7 common ways to generate passive income.
If your business owes any money, this is a good time to pay it off. Debts typically accrue additional expenses in the form of interest; if you pay them off sooner, that’s less interest you’ll end up paying. And if you face a downturn, Stalcup says having less debt is “a blessing.”
“[Paying down a debt] alters the debt-to-equity ratios,” says Stalcup. “If there’s cash to pay down high-interest debt, that should be a priority.”
Plus, owing money has the potential to give creditors control of your assets.
“If a business owner owes the bank and creditors, they may have covenants and restrictions on the spending of the company’s cash,” he says.
Improve your business
Have you been putting off a business investment because of a lack of funds? Excess cash flow could indicate it’s time to make that improvement in your business. Maybe it’s a website redesign, your first employee, or a new product idea. Whatever it is, make sure it’s a true investment and not just a purchase for the sake of it.
“Plowing this free cash flow back into high-ROI investment opportunities would be the most logical,” says CPA Riley Adams of Young and the Invested. “Doing so will lead to greater revenue generation or cost suppression and ultimately higher ongoing profits.”
Take a well-deserved break
Okay, bear with me on this one. Spending your extra money on a flashy vacation isn’t the soundest financial advice. But there could be a benefit to giving yourself some rest and reprieve from the daily grind.
For one, this could help avoid burnout, giving you a chance to return refreshed and recharged—ready to go with new inspiration and ideas.
“Experiential purchases (money spent on doing things) tend to provide more enduring happiness than material purchases (money spent on having things),” says one study.
But there could be a more direct financial benefit too.
“From a business standpoint, if the sole owner of a business takes out a greater salary/bonus, and the cash flow is there to support it, the business value may not go down,” says Stalcup.
“In small business valuation, we often look to Seller’s Discretionary Earnings (SDE) as a starting point to put a value on the enterprise and its cash flows,” he says. “To calculate SDE, we add back the owner’s salary to the cash flows to get to calculate a business value.”
If you pay yourself a bonus and use that to fund your holiday, this won’t end up hurting the enterprise value of your business whatsoever.
Negotiate lower rates for upfront payment
Take an inventory of your vendors—this includes software, manufacturers, service providers, etc. Then look at how you pay them. Is it weekly? Monthly? Per order? For those you pay in some form of installments, see if you can negotiate lower vendor rates for full upfront payment.
Many SaaS companies with monthly subscriptions, for example, will discount the rate if you pay for a full year at once. Zapier, for example, has monthly and annual plans for individuals and companies.
Diversify what you do with your cash flow
Perhaps the best lesson any entrepreneur can learn is to diversify your income streams. This provides more protection for your cash flow. For example, if business A has a bad quarter, you still have business B and C to fall back on. This also means diversifying your investments.
Matthew Ross, co-owner and COO of My Slumber Yard, has had success in doing this with his business investments.
“We don’t just put all the extra money towards one specific marketing campaign or a big hiring spree,” he says. “We look at it as if we’re building a stock portfolio: They key is to diversify.”
The company splits the money up between owner dividends, advertising, and human capital.
“Overall, we’ve found that a nice balance between the three is the optimal way to use profits,” Ross says.
Moving forward with your cash flow investments
The best move for your excess cash flow really depends on your unique business, financial, and lifestyle goals.
“Bottom line, if the surplus cash flows are expected to continue for some time, the business owner needs to weigh their options,” says Stalcup.