What is cash flow and why is it important for small businesses?

December 20, 2021
5 minutes read

Cash flow: It’s a term you’ve probably heard before, but might not understand yet. As a small business owner or freelancer, it’s important to understand what cash flow is and how it impacts your business, since the survival of your business depends on it.

What is cash flow?

Cash flow measures the net amount of cash and cash equivalents coming into and going out of a business over a set period of time. It indicates the financial health of your business by showing how much cash your business has on hand.

Studies show that one of the top reasons most businesses fail is because they don’t have enough cash on hand.

Cash flow management lets you forecast expenses, prepare for dry months, and even know what to charge your clients. For example, being able to tell if you'll be bringing in less money in the coming month will allow you to spend and invest your money responsibly.

Three arrows pointing to floating, sparkling coins, representing cash flow.

Chapter 1: What is cash flow?

Let’s answer the question on everyone’s mind: What is cash flow? Defining cash flow is simple: Cash flow represents the movement of money in and out of your business.

Think of it this way: Your cash flow represents all the transactions you make. When you have more than enough money in your account to cover your bills, you have a positive cash flow. But when the cash flowing out of your business (i.e. expenses) exceeds the cash coming into your business (i.e. revenues and income), that’s when you have a cash flow issue.

Accounts receivable versus accounts payable

It’s important to differentiate between accounts receivable and accounts payable. Accounts receivable represents your assets, like a positive bank balance or cash on hand. Accounts payable rounds up your liabilities, like payments or debts you owe.

What is accounts receivable?

Accounts receivable is an asset account that keeps track of money coming into your business (money you receive from your customers for the goods and services you provided). This is an important part of calculating the profitability of your business.


What is accounts payable?

Accounts payable is a liability account that tracks the money leaving your business (as we mentioned, this is the money that you owe). This may include employee payroll, bank loans, or other business expenses.

Accounts Receivable: the money you owe to vendors. Accounts Payable: the money owed to your business.

Determining the profitability of your business

You can determine profitability by adding up all of your assets, including accounts receivable, and subtract your total accounts payable. If the result is positive, your business is profitable. If it’s negative, then you will need to look at ways to increase profitability.

Another key point to note: A positive cash flow doesn’t always equal profit.

The difference between profit and cash flow

Because cash flow only represents the balance in your bank account, it’s possible for your business to turn a profit and still have zero cash. For example: You might earn a 30% profit on every product you sell, but if you have more expenses than income, you still have negative cash flow.

Your business could turn a profit of $20,000 one month but only see $8,000 of that in cash flow because the rest is pending in accounts receivable. That’s why profit and cash flow aren’t interchangeable terms.

Plants with coins instead of flowers being watered, representing flourishing cash flow.

Chapter 2: Why cash flow is crucial

Cash flow is the lifeblood of your business. Positive cash flow is what makes your business flourish, and the pace of cash flow is just as important as having cash flow at all. When you have enough money put aside, it’s easier to pay your expenses as they come due. But when your cash only trickles in, you can stumble into cash flow issues.

Cash flow for small businesses

If you’re thinking about starting a business or you recently launched a new one, you’ll need to invest some cash in the early days to get set up. You might need to buy new equipment, pay for a website, or put down a deposit to rent office space. That’s why you shouldn’t be alarmed if you see more money leave your business than come in—at least initially.

"[Cash flow problems] might be good news, because as a business is growing is often when you start to have those cash flow problems," said Facebook's Sheryl Sandberg in an interview with Inc.

To fund these expenses and still have capital left over for when your business opens its doors, you’ll need to understand how to manage and protect your cash flow. For starters, you may need to invest some of your own money to cover your startup costs. For those who have a tight budget, you can also explore other financing options to cover startup costs, such as:

It’s common for small business owners to rely on these kinds of funds until their businesses begin to grow.

Seasonal businesses and cash flow

If you’re a seasonal business owner, strong cash flow management skills are even more important. Because you’ll see an influx of cash during a specific season and little-to-no cash the remaining months of the year, learning cash flow management can help keep your business finances in the black even in your offseason.

These simple steps will get you started in the right direction:

1. Put together a cash flow statement

A little later, we’ll show you how to generate a cash flow statement. For now, it’s important to understand that putting together a cash flow statement will show all your business transactions (both income and expenses).

It generally includes three sections: cash from operations, cash from financing, and cash from investing.

2. Forecast your expenses

Using your cash flow statement, you can see which months you’ll likely feel the pinch in your cash flow. Once you identify those periods, you can create an expense forecast. Basically, you’ll estimate your operational costs for those months, including your rent, payroll, and any other recurring monthly expenses to see how much you’ll need on hand.

While a cash flow statement allows you to observe the cash history of your business and analyze any patterns, an expense forecast helps you make an educated guess about your future business spending.

Using your expense forecast, you’ll know exactly how much to set aside for slower periods.

3. Plan ahead

Whether you’re a seasonal business owner or simply experience slow sales periods throughout the year, planning ahead can save you time and stress. Here’s where forecasting from the last step comes in.

To prevent any problems before they crop up, take those anticipated payments for your slower seasons, figure out which payments you can and can’t delay, then set aside enough cash from peak sales periods to cover all of your operating expenses during off-season. Also consider setting aside an extra cash buffer to cover any unexpected costs.

To help you accurately forecast your expenses and plan ahead, try creating a calendar for your operating expenses. Add entries for all recurring payments and their due dates. That way, you have an at-a-glance view of your expenses and when they’re due.

Arrows pointing to a blue laptop.

Chapter 3: How to understand, calculate, and manage cash flow

Whether you’re an established business or a startup, hiring an accountant or bookkeeper might not be financially feasible just yet. Fortunately, when it comes to calculating cash flow, you don’t need either one. Using tools like Wave's free accounting software and cash flow calculator, you can track your cash flow automatically.

Wave also syncs with your bank accounts, is compatible with other accounting software packages, and gives you access to one of the most important tools you’ll need: a cash flow statement. Cash flow statements shouldn’t be confused with income statements or balance sheets. Each of these are distinct from one another and serve different purposes.

Cash flow statement versus income statements and balance sheets

Income Statement

An income statement shows your business’s financial performance during a given accounting period.

  • Is it overperforming?
  • Underperforming?

These are questions an income statement helps answer.


Balance Sheet

A balance sheet, on the other hand, tracks your company’s liabilities and assets over a period of time. This report is a snapshot of your business’s financial health at any given moment.

  • What debts does your business have?
  • What assets does it have?
  • What is your business worth?

For larger corporations, it’s also what you use to calculate shareholder equity and the rate of returns.


Cash Flow Statement

Last (but certainly not least), cash flow statements show how cash is moving into and out of your business. Typically, these statements break down cash flow activity into three different segments for easier tracking: operating flow, investing flow, and financing flow.

The terms may sound complex at first glance, but these segments can help you understand the nature of all your business transactions.

  • Operating Flow: Operating flow refers to any income or spending that comes from your net income. That can include buying merchandise and revenues from selling your products or services. These transactions happen naturally as a result of operating your business day-to-day.
  • Investing Flow: As the name implies, investing flow covers business investments. When you buy an item, like a commercial property or equipment, that will be used over and over to increase your business’s efficiency or profitability, that transaction falls in the investing flow category.
  • Financing Flow: If you take out a business loan or pay out dividends to shareholders, these activities fall into the financing flow category. This segment covers any transactions around dividends, debt, and equity.

A diagram showing “The biggest pain points for getting paid by customers.” A large blue circle that says “51%” and represents the amount of small business owners chasing after customers who delay/default their payments.” A smaller pink circle says “23%,” and refers to the cost of receiving payments being too expensive. A slightly smaller orange circle says “21%” and represents keeping track of all payments received. Another purple circle says “21%” and represents entering data.

Source

How do I talk to customers about how I want to get paid?

So, now that you understand what cash flow is, let’s cover how to manage it. One important factor is talking to your clients about getting paid on time.

Handling money-related conversations with customers can be tricky (not to mention awkward). But when you deliver a service or a product, you deserve to get paid. To ensure you get what you’re owed, follow these steps:

1. Be upfront

Being straightforward with your clients is often the best approach. Clearly communicate details about the payment contract, including:

  • Payment amounts
  • Due dates
  • How payments should be made
  • Who payments should be made payable to
  • Where payments should be sent

2. Bring up payment penalties or rewards early on

As you’re putting together a contract or outlining payment expectations with a new client, make sure to mention whether you charge a fee for late payments, as well as any incentives for early or on time payments.

3. Talk about your billing process

Be clear about how and when clients can expect to receive invoices—this prepares them for what’s to come and is, again, another way to delve into other payment-related topics.

If you use invoicing software like Wave, you can easily send and track invoices like a pro.

How do I follow up on outstanding invoices without upsetting a customer?

A recent survey by Wave revealed that 25% of the small businesses polled waited a year to get paid, or still haven’t been paid at all. 70% waited between one and six months to get paid. Almost half of the surveyed businesses said cash flow was a major struggle.

For a lot of small business owners, dealing with outstanding invoices is a reality. No matter how organized you are, you may have a few clients who don’t pay on time (or at all). When that happens, here are a few things you can do to touch base with your clients without ruffling any feathers:

1. Automate the process

The best and easiest way to handle invoices and payments is by automating the process.

Money management tools like Wave offer features like recurring invoicing and automatic credit card payments, so you won’t have to chase down payments. You can also send statements to follow up on overdue customer accounts, and set automatic reminders to nudge your customer to pay on time.

Invoicing software also makes it simple to customize invoices, send billing and invoice reminders, and receive instant updates for your invoicing and payments data. Automating these tasks removes them from your to-do list and can help you get paid faster.

2. Send an email reminder

Following up on payments is never fun, but the best part about sending an email reminder is that you have an opportunity to think through your words and shape your message. Your tone may differ depending on how late the payment is, but initially aim to be firm and polite.

If you’re following up for the third or fourth time, your tone may be more assertive.

3. Get on the phone

If you still have an unresponsive client after a month, it’s time to pick up the phone.

First things first: Make sure they received your invoice. There’s always a possibility they were busy, their email changed, or, if you’re dealing with a larger company, your email could have been sent to the wrong person or department. There’s also the possibility that they saw it and pretended that they didn’t.

Once you know they’ve seen your invoice, you can move into discussing its past-due status.

4. Take more stringent measures

If none of the above work, you could turn the invoice over to a collection agency or report the matter to a credit bureau.

How to avoid bad customers

Most customers have every intention of paying you, but there are always a select few you’re better off without. Here are a few tips to make sure you’re attracting the right customers to your business:

  • Go for quality versus quantity: You’re better off with seven customers who pay on time than a hundred who pay little or nothing.
  • Don’t try too hard to be affordable: If people are hesitant about your prices, it probably means you’re beyond their budget—in that case, you’re better off not forcing the sale.
  • Ask for a deposit: Securing money up front can help soften the blow if the client defaults on future payments. The more you can secure upfront to cover the cost of your product or service, the better.

Now that we have a firm grasp on how to handle cash conversations with tact to encourage positive cash flow (also known as “inflow”), let’s talk about best practices for cash outflow.

Everything you need to know about cash outflow

There are many ways cash can leave your business. Here are a few best practices to help you better manage that money:

Managing payroll

Of all the payments you’ll make as a small business owner, one of the most important will be to the people who help keep your doors open every day—your employees. Manage your payroll well, keep employees happy, and avoid trouble with the law by following these tips:

  • Write down your payroll dates: It’s easiest to make payments when you know when payroll is due. If you know this then all you have to do is make sure you have enough cash on hand as the date approaches.
  • Pay electronically and keep immaculate records: Automating your payroll can be a timesaver. Just be sure to classify each employee correctly (as a W-2 or 1099 worker) so their paychecks reflect the right deductions and taxes. Payroll tools help you run payroll for both contractors and W-2 employees quickly and accurately. They also keep pay records for each employee, which comes in handy during tax season and for other purposes as they arise.

For more information about payroll forms - what they are, what they’re for, and when to use them - you can visit our Payroll Education Center.

Check it out

Paying contractors

You can pay contractors on an hourly or per-project basis. Whichever you decide, make sure it’s clearly detailed in your contract along with other important information like project duration, payment frequency, deadline terms, and monetary penalties for late work.

In the U.S., you typically won’t withhold federal or state income tax from your contractors’ pay—they’ll be responsible for paying for those on their own.

If you’re processing payroll through a system like Wave, you can easily distinguish contractors from W-2 employees so the correct withholdings apply to each employee. Wave also tracks all the payments you make so that you have a readily accessible list of all payroll amounts and dates when and if you need it. And with the self-service features of Payroll by Wave, employees can access any pay stubs they need, anytime they need them.

Paying taxes

As a business owner, there’s no getting around taxes. You need to pay them and in most cases, you’ll need to pay every quarter.

Setting money aside will ensure you avoid any fines or penalties from the IRS. You can get an idea of what you can expect to pay each quarter (and what you should be putting away each month) by viewing the IRS 1040-ES form.

Paying bills

For bills, know who you owe, how much, and when they’re due. Keep a summary of these basics readily available and review them regularly.

You should also schedule time on a regular basis to fully review your accounts payable and accounts receivable reports. The timing of this review depends on the nature of your business and whether or not you’re having cash flow issues. Plan ahead and compare your expenses to your estimated revenue. This will not only help you to stay on top of your invoices and bills, but you may be able to set stronger, more realistic financial goals for your small business.

Once you have a firm understanding of how to manage the money moving out of your business, you’ll have a firm cash positioning and can maximize how you use your cash flow statement.

A golden coin in the centre of a document. A bullet list and an icon of a graph point toward the coin. Three arrows point away from the coin, leading to a graphic of a home office, text message, and people connecting.

Chapter 4: How to calculate your cash flow

An important part of understanding cash flow is learning how to analyze it. The good news is, cash flow statement templates make calculating your cash position a breeze. Other free resources, like Wave, make the job even easier by displaying your cash flow ins and outs, cash positioning, and net change in simple graphs and charts.

Whichever tool you choose to use, it’s important to remember a cash flow statement simply gives you a high-level overview of your small business finances.

If you want deeper insight into your cash position, like finding out what you have leftover that you can use, you should be calculating what’s called your free cash flow (FCF), which is different from regular cash flow. FCF is a formula that allows you to find out how much cash you can safely use. Fortunately, calculating your FCF is almost as easy as figuring out cash flow. Just have your company’s income or balance sheet handy and follow this free cash flow formula:

Net income + Depreciation/Amortization – Change in Working Capital – Capital Expenditure = Free Cash Flow

Okay, that was a lot. Let’s break it down a little more:

  • Net income is how much money your business makes, once you subtract the money it spends.
  • Depreciation refers to physical assets, like equipment. Amortization refers to non-physical assets, like trademarks. Both processes involve determining the value of the assets over their lifespans to reduce your taxable income.
  • In simple terms, working capital refers to your total current assets subtracted by your current total liabilities.
  • Capital expenditure is the money you invest in long-term assets, like equipment and the maintenance of that equipment.

One thing to keep in mind is that FCF takes into account only what you’re spending currently, not what you’ve already spent in the past. If you’ve fallen behind on debts or have other financial obligations, you should consider taking care of those first with your current FCF instead of investing that cash someplace else.

If math is not your strong suit, we’ve created a walkthrough of 6 cash flow formulas below that can help you gain insight into your business finances:

Create a cash flow projection

Knowing whether the next month will see a financial feast or famine can help you make better decisions about spending, saving, and investing in your business today. If, for example, your cash flow projection suggests you’re going to have higher-than-normal costs and lower-than-normal earnings, it might not be the best time to buy that new piece of equipment. On the other hand, if you’re seeing a potential surplus, it might be the right time to invest in the business.

Forecasting your cash flow months or even a year ahead of time can help you plan your spending around your projected cash inflows. That’s where a cash flow projection comes in.

  • In practical terms, a cash flow projection chart includes 12 months laid out across the top of a graph, and a column on the left-hand side with a list of both payables and receivables.
  • This column typically begins with “operating cash,” or unused earnings from the previous month. For example, if your cash flow projection for January suggests a surplus of $5,000, your operating cash for February is also $5,000.
  • Below operating cash, list all expected accounts receivable sources—such as sales, loans, or grants—leaving a space at the bottom to add them all up.
  • Next, list all potential payable items—such as payroll, overhead, taxes, and inventory—with another space to add their total below.
  • Once you have your numbers prepared, simply subtract the total funds that are likely to be spent from the cash that is likely to be received to arrive at the month’s cash flow projection.
  • Once you’ve calculated your monthly cash flow, take the final number and list it at the top of the next month’s column under operating cash, and repeat the process until you’ve got a forecast for the next 12 months. After the end of each month, be sure to update the projection accordingly, and add another month to the projection.

If you prefer to use a ready-made chart to help you create your projection, you can pull your financial data from the Reports section of Wave and feed it into this cash flow forecast template.

A closeup of a timer clock face. The time that has passed is white. The time that has not passed is blue.

Chapter 5: How to optimize your business around cash flow

You can see by now how businesses revolve around cash flow, no matter how profitable they may be. One poorly implemented cash practice can send a business spiralling, which is why it’s important to keep your cash flow steady and stable.

To help you optimize your business’s cash flow, follow these expert pointers:

Decide payment terms early on

Getting paid on time is important, otherwise you run the risk of seeing your cash flow dry up. One way to sidestep any issues is by setting clear payment expectations from the get-go with your clients—both in a contract and verbally.

A strategy you could use to incentivize customers is offer them payment discounts when they pay early. For example, knock 2% off the payment balance or apply that discount to a future payment. Subsequently, you can penalize clients for late payments by charging fees and interest.

Whichever approach you take, just be sure to detail your payment terms in the client contract so the penalties don’t come as a surprise.

Make it easier to pay

While most customers have every intention of paying you, tough payment processes can get in the way and prevent even some of the timeliest customers from pulling out their wallets until the last minute. The lesson to be learned? Make your process as simple and convenient as possible. For example, reduce the number of clicks it takes to make a payment. Or offer multiple ways to pay. The easier your process, the faster you’re likely to see cash roll in on time.

Wave, for instance, allows businesses to collect and receive online payments from customers in as little as two days, directly from an invoice. Allowing your customers to make payments via credit card and bank transfers is not only convenient for them – it increases your likelihood of being paid on time by 15%.

Manage your inventory well

One nightmare scenario for business owners is having hard-earned dollars tied up in idle or wasted inventory. For instance, as a restaurateur, if you spend $500 on lettuce, it’d be a shame to use only $150 worth and see the remaining $350 of greens spoil and go straight to the trash. That money would've worked harder for you someplace else. That’s why with inventory, you’re better off ordering just enough to keep your holding costs low and free up cash.

Striking the right balance can get tricky; fortunately, technology removes much of the burden of having to manually track and forecast what you’ll need to run an effective daily operation. Wave, for instance, makes it simple to monitor your inventory costs, record purchased inventory and sold inventory, and access reports for it all. You can also use inventory management software like Shopify POS or TradeGecko to monitor and create season-specific stock forecasts to ensure you have just the right amount of products on hand to meet your needs.

With these tools on hand, it’s easier to manage your inventory levels and purchase products at exactly the right time and in the right quantity—just when you need them.

Have a well-rounded marketing approach

If you’re targeting customers through only one marketing channel—say print advertising—you’re limiting your reach. Instead, embrace an approach that attracts customers through multiple mediums simultaneously, like print ads plus social media marketing and a Google AdWords campaign. Focus on the marketing tactics that make sense for your niche and your business. A multi-channel marketing approach will not only increase your business’s exposure and attract more sales, but it can help boost your cash flow and bring in revenue at a steadier pace.

But steady is only one part of the equation. If you want your business to operate like a well-oiled machine, your cash needs to come in steady and fast. So, next we’ll tackle how to optimize the speed of your cash flow.

A pink snail with a golden, sparkling coin instead of a shell.

Chapter 6: How to get faster cash flow

It happens. Your records show a profit of $20,000, but all you have in your business account is $3,000, which might tide you over until the following week. But when this scenario repeats itself regularly with no solution in sight, you’re eye-to-eye with a major cash flow issue.

The good news is you’re not alone. Businesses everywhere face the same struggle every day. As we mentioned, at the end of the day, profits mean little if you don’t have enough cash to run daily operations. That’s why, when it comes to cash flow, speed is key.

Unfortunately, many small business owners end up sacrificing speed in favor of more cash, which is a mistake to avoid at all costs.

Understanding the importance of speed over dollars

Say a customer makes a purchase for $1,000. You have two choices: let them pay by card and get the full balance minus card processing fees within seven days or settle on a payment plan, avoid the fees, and get paid in 38 days. Which do you choose?

Text says: “A customer makes a 1, 000 purchase.” An arrow points to text that then reads:

Most people would go for the monthly instalments to avoid the credit card processing fee, which might tally up to about $30 for every $1,000, for example. But for that $30, you’d be sacrificing an entire month without those funds. From a cash flow standpoint, you’re much better off paying the $30 fee and having that settle in your account in exchange for much speedier access to funds.

Here’s why: receiving cash every seven to 10 days and having it leave every 30 days keeps your business looking pretty, cashflow wise. Cash velocity is crucial in business. To ensure your cash flow comes in quickly, here are some best practices to follow:

Invoice your customers right away

Ultimately, the sooner you invoice, the sooner you can expect to get paid. When you’re prompt with invoicing, it sets the precedence for your customers, showing them you’re serious about collecting payments on time and that you’re keeping organized about when and how much they owe you.

Charge enough for your services or products

Understandably, you want to be affordable for your clients, but not at the risk of short changing yourself. Remember, just because something feels pricey to you doesn’t mean it will to your customer. It’s all about how the customer perceives the value and benefit of what you’re offering.

Bottom line, don’t be afraid to charge your worth, especially if you’re selling a large volume, collecting payments and time, and still struggling with cash flow. That’s probably a strong indicator you’re not charging enough. To learn more about how to calculate your pricing, check out our Complete Guide to Getting Paid.

Re-evaluate operating expenses

If your price point is on target, you’re collecting on time, and you’re seeing a high volume of sales but you’re still having trouble making ends meet, it’s probably time to revisit your most routine costs: your daily operating expenses. More than likely, you’re spending on things you could do without. Taking time to re-evaluate expenses this way can help you save dollars, reintroducing more cash flow into your business.

To start, analyze a few months’ worth of bills to figure out which expenditures are the heaviest financial burden on your business:

  • Are your utilities too high?
  • Are you paying for software you don’t use regularly?
  • Are employee salaries eating at a big chunk of your cash flow?

If so, consider energy efficient fixtures to lower utility bills. Or consider reducing your employer headcount. One or a combination of the two could curb costs simultaneously on payroll and extra energy consumption by non-essential staff.

Liquidate old inventory

Stale inventory doesn’t bode well for you or your business. Meaning you should only order what you need, when you need it. But if it’s too late for that, then it’s time you take action to release trapped cash. For instance, you could knock down prices, offer special financing options or extend a bonus to salespeople who help sell idle inventory.

Pay vendors at the right time

As a business owner, you’ll be juggling multiple payments at once. Suppliers, your landlord, and credit card companies will account for a chunk of that cash flow. Although it might be tempting to pay everyone off as soon as you get a large payment in, cash position wise, that’s not the best idea.

Time your payments strategically to make sure you’re not draining your account all at once. Pay too soon and you may miss out on being able to use that cash flow in more lucrative ways, like taking advantage of a steep discount temporarily offered by a particular supplier.

The equipment you use helps determine what you charge. I also looked at my experience within the industry. I'm pretty intermediate so I can charge more than someone who's just starting out. You have to be honest with your experience and how much you've invested.

- Tatiyanna Williams-Britton, TruCreates

The sun has a dollar sign in the middle. Rays of sunlight shoot out into a blue sky with clouds.

Chapter 7: Capitalization and outside sources of cash

Inevitably, you’ll run into circumstances where you’ll need to rely on cash. For instance, you may decide to expand your business, or experience a lull in business when a cash reserve could help you breathe easier. But many entrepreneurs too often make the mistake of not setting enough capital aside to help them through scenarios just like these.

Fortunately, you have several options to get the cash you need, whether you’ve been in business for some time or are just starting out:

Crowdfunding

If you have a business idea that helps solve a problem, is innovative, or appeals to the masses, crowdfunding could be the perfect way to pocket some cash. Kickstarter, Indiegogo, and Crowdfunder are popular crowdfunding sites that connect you to individual contributors. In essence, you set a fundraising goal and raise funds from people who support your idea.

One thing to bear in mind is that some of these sites have strict stipulations, like only giving you the full amount of donations raised if you meet your complete funding goal. So, make sure you go through their guidelines and terms carefully.

Consider cash-back credit cards

Credit cards are a great way to create float and build credit for your small business. If you’re already spending a substantial amount on credit cards and are diligent about paying off your balance, you might qualify for a rewards card. This means you can get money back just for using your card to make purchases you’re already making.

As long as you’re a responsible consumer and prompt about making payments on time and in full, rewards cards and credit cards for small businesses can be a great win-win for you and your business’s cash flow.

Apply for a loan

Loans are probably the most natural option you think of if you need additional cash. Fortunately, there are many types you can choose from based on your business needs, including:

  • Invoice factoring: With this option, a third party, called a factor, buys outstanding invoices from you at a discount. As these invoices come due, the factor collects on them. In the meantime, you walk away with a stash of cash that you can use however you want. This is a more instantaneous way for businesses to fulfill cash flow needs.
The title says “Invoice financing basics.” 1. Company sends invoice to customer with purchase. 2. Company sells invoice to financier 3. Company receives 70-85% if invoice in cash advance. 4. Customer pays invoice to financier. 5. The company is eligible for a rebate for the remainder of the voice, minus a fee.
  • Cash-flow loans: This is where the bank lends you money using your expected cash flow as collateral for the loan. Cash flow loans might be something you consider when you need working capital right away but don’t expect to see it in your cash flow until much later.
  • Taking on a partner with capital: This option allows you to take on a silent partner who invests in your business without interfering in its daily operations. In return, you promise them a stake in your business. This is certainly an option worth considering if your business is profitable and you have the luxury of relinquishing a small part of your profits.
  • Bank loans: If none of the above sound like the right fit for you, you could go the traditional route and consider personal and small business loans. A professional banker can present you viable options based on your credit situation and business needs.

Always practice caution before deciding to take on any debt. If you’re already struggling financially or in a considerable amount of debt, shouldering a heavier financial burden will only worsen rather than help your situation. In that case, your best bet is to speak to a financial expert to determine the best course of action for you and your business.

Learn how to find the right loan for your business, read up on finding a small business loan.

Open a business savings account

Once you have a solid stash of cash, it’s time to find the right home for it. You probably already have a checking account where you draw funds and write checks from, but if you want to safeguard your cash, your best bet is to open a business savings account. This way your funds will remain segregated so you don’t accidentally dip into your rainy day/investment cash. Plus, savings accounts usually offer a slightly higher interest rate, so you’ll see your money grow a little faster, even if it’s by pennies and nickels.

A glass mason jar labelled “Funds.” It has stacks of gold coins inside, and one coin is being dropped inside.

Chapter 8: Adjusting your business for a cash flow shortage

A cash flow shortage can set you back months. Even worse, it can make it difficult for you to meet your accounts payables for employees, vendors, and your landlord.

It takes skill to adjust your business against a cash flow shortage, but it’s not impossible. Here are some dos and don’ts to consider if you find yourself strapped for cash:

Don’t stop marketing and promotion

Unless you’re maxed out to the brim on your capacity to take on new clients, there’s no such thing as over-marketing. In fact, marketing done right is what can break you out of a rut and help kick start sales and curb your cash shortage. That’s why, when it comes to eliminating expenses, marketing should be one of the last things on your hit list.

That said, marketing is only important if it’s effective. If you’re not seeing an uptick in foot traffic from your efforts, it’s probably time to revisit your strategy.

Revisit your invoicing process

If you’re already sending your invoices on time, there is still something you can do to bring in funds faster. For instance, try shortening the length of time that a payment is due upon receipt of an invoice.

A simple adjustment like this can help you see cash sooner and throughout the month instead of in one big chunk at the end.

Understand your spending habits

Keeping tabs on your spending is the most effective way to tackle a cash shortage. But when you’re tallying up your expenditures, take it one step further and categorize them to see which area of spend is eating away the most at your dollars.

Using software like Wave eliminates a lot of the manual process and saves you time. For example, Wave’s reporting features give you a glimpse into your most frequent spend categories so you can quickly figure out where you’re putting the most money.

Why did you pay more in payroll one month? Why did your food costs increase another month? Once you have the answers to your why, you can come up with a game plan for the future.

Compare competitors

If you’ve done a deep dive into your business but you’re still not sure where you’re missing the mark on spending, it might be time to do a comparison with your competitors. For instance, if you run a dealership, probe another car dealer to see where they’re spending the most. This is a particularly feasible option if you have friends in the industry. If you don’t, you can connect with some on platforms like Meetup, which allows you to collaborate with others in your industry.

Another idea is to find an accountant who has experience working the books of people in your industry. Without compromising the identity of clients, they can clue you in about average spend in different categories so you can compare how far off the mark you are.

Cut back on your business budget

Analyzing your business expenses allows you to see which ones are necessary and which ones are unnecessary. Prioritize expenses that are non-negotiable (utilities, supplies, etc.) and cut back or delay ones that aren’t. For more information on slimming down your budget, read our tips on managing your business finances.

Now that you know how to optimize your business around cash shortages, let’s talk about common cash flow mistakes business owners often make and how you can avoid them.

The end of a pencil is erasing a pink background, leaving a white streak.

Chapter 9: Biggest and most common cash flow mistakes to avoid

It’s common to make cash flow errors when you’re a new business owner. Here are the most common ones and how you can avoid them:

Being too optimistic

Business owners by nature are optimists. But when it comes to cash flow, that attribute can be a downfall. For instance, don’t spend too much in hopes that you’ll make it up tomorrow.

When you’re starting out, it’ll be tough to gauge how much you can realistically expect to make. Instead, partner with a mentor or industry expert to gain a sense of what you can anticipate in terms of cash flow. If you feel brave enough, request a peek at their cash flow statements and do a cash flow analysis. To safeguard your expectations, subtract 10-15% to account for potential variations or shortfalls.

Overspending too soon

One way to avoid spending too much is by creating a business plan where you map out which milestones you should meet before you make certain investments. You can also create a budget for each. Staggering your purchases over time will give your business an opportunity to “heal” as you spend and grow cash flow at a healthy pace.

Accumulating too many past-due receivables

Making a sale is exciting, but that excitement can quickly dwindle when customers don’t pay on time. Being on the lookout for new clients and sales is a good thing, but make sure you’re also keeping an eye on outstanding receivables that are plugging up your cash flow.

Be regular about tracking invoices, sending reminders, implementing penalties and embracing stringent measures to collect payments on time. Past due receivables are the start to a slippery slope of cash flow issues.

Not using a cash flow statement to anticipate your budget

Your cash flow statement is probably the single most powerful tool you have in your arsenal. It’s particularly invaluable when it comes to helping you plan and prepare for cash flow surges and setbacks.

For instance, without the help of a cash flow statement, you could find yourself caught off guard by a seasonal dip in business. And if you happen to fall behind in payments because of it, you could cause damage not only to your reputation and relationships but also to your credit and financial standing.

Not having enough of a cash buffer on hand

Many small business owners enter the business realm with little to no reserve for rainy day funds. To avoid this dilemma, a good best practice is to have at least two months of operating expenses in your business savings account. This way, even if you experience unexpected dips in business or stalls with cash flow, you’ll have ample reserves in place to protect yourself.

Congrats, you made it to the end!

Now, let Wave monitor and forecast your cash flow for you. No jargon, no training, no payments necessary.

Create your free account today
By Wave Staff

The information and tips shared on this blog are meant to be used as learning and personal development tools as you launch, run and grow your business. While a good place to start, these articles should not take the place of personalized advice from professionals. As our lawyers would say: “All content on Wave’s blog is intended for informational purposes only. It should not be considered legal or financial advice.” Additionally, Wave is the legal copyright holder of all materials on the blog, and others cannot re-use or publish it without our written consent.

Create your truly free Wave account today.

Let's do this