8 Cash Flow Management Best Practices To Improve Business Longevity – Tillful (2024)

Executive Summary

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How long could your small business stay open if your regular cash inflows came to a screeching halt? If you answered about a month, you’re in line with most small businesses in America.

Findings from JPMorgan Chase Institute’s inaugural report on the small business sector revealed that the cash reserves of most small businesses were insufficient to tide them through a significant economic downturn or crisis situation. Unfortunately, this fact became very evident when the coronavirus pandemic hit and many businesses had to close their doors.

So how can your small business better prepare for the future? Here’s a closer look at the typical cash reserves that businesses hold today (in terms of cash buffer days) and how you can improve yours with 8 cash flow management best practices.

What are Cash Buffer Days?

Before we get started, what are cash buffer days in the first place? JP Morgan Chase defines them as the number of days of cash outflows a business could pay out of its cash balance when its inflows stop. Your business’s cash buffer days can be calculated using the following formula:

Average Cash Balance / Average Cash Outflow = Cash Buffer Days

Cash Buffer Days of Small Businesses

So how many cash buffer days do most U.S. small businesses have, on average? The JP Morgan report mentioned above explored the financial lives of small businesses by analyzing data constructed from over 470 million transactions conducted by 597,000 small businesses. The findings showed that the median small business in America holds only 27 cash buffer days in reserve. However, cash balances vary widely across and within industries as can be seen in the table below.

Overall, it was found that half of all small businesses hold a cash buffer of less than one month. The bottom quartile of small businesses holds fewer than 13 cash buffer days in reserve while the top quartile holds over 62. That means the businesses with the most cash buffer days would still find themselves without enough money after about two months. Let’s take a look at how cash flow management may be able to help.

What is cash flow management?

First, to understand cash flow management, you need to understand cash flow — or the total amount of money that’s transferred into and out of a business. Cash flow management, then, is the process of optimizing a company’s cash flow through a process that involves audits, monitoring, analysis, and ongoing adjustments.

Why is cash flow management important?

Cash flow management is important because it helps to ensure that small businesses don’t run out of cash on hand, which can limit their ability to keep the business afloat. It’s really the lifeblood of a business that enables it to not only survive but thrive.

The pandemic highlighted how important cash flow is during liquidity crunches. If you don’t have positive cash flow, you won’t be able to build cash buffer days which means you can’t survive situations where your cash inflows are temporarily halted.

Overall, poor cash flow management can help to explain the lack of longevity in small businesses. The JP Morgan report estimates that a third of new businesses exit within their first two years and a half exit within their first five years. Small businesses may be the anchor of the US economy but they are prone to low survival rates. This only reiterates the importance of having strong and continuous positive cash flow which results from strategic cash flow management practices.

8 Best Practices for Managing Cash Flow

How can a business increase the amount of cash it has on hand at all times? Here are some cash flow management best practices to consider.

1. Audit Your Company’s Financials

The first step in controlling your cash flow and ensuring you have enough cash on hand is understanding where you’re financial situation currently stands. So, if you haven’t performed a cash flow analysis lately – it’s time. Pull out your balance sheets and accounting software to find out how much money you’re bringing in, how much goes to business expenses, and how much free cash flow you have, if any.

During this process, keep an eye out for any business expenditures that you may be able to cut or reduce. By the end, you should have a good understanding of your company’s financial health along with some ideas about how you can improve it and increase your positive cash flow. You can also bring in an expert to help you with this audit and analysis.

2. Streamline Your Accounts Receivable

Next, assess your accounts receivables. One surefire way to bottleneck your cash flow is to have your invoices sitting around not getting paid promptly. A few common practices that can slow down the payment of invoices include waiting until a certain date to bill all your clients and giving them extended periods to pay. The delays can leave you without the amount of cash you need to comfortably meet your financial obligations.

To get paid faster, bill customers as soon as they’ve received a service, versus waiting until the end of the month to bill all of your customers. You can also require deposits upfront or break up the payment into milestones (if your service is delivered in multiple stages). By doing so, you’re not waiting until the end of a deal, or beyond, to receive all of your compensation.

If you give customers extended payment terms, such as 90 days, consider shortening the period of time that’s allowed. Further, incentivize early payments by offering customers discounts if they pay by a certain date. On the flip side, you can charge fees for late payments. Additionally, if you haven’t implemented online invoices and payments, consider those options to enable quicker payment processing.

3. Optimize Your Accounts Payable

As you review your business expenditures, one area to assess is the pricing you’re currently getting from suppliers or vendors. Although you may be comfortable with your suppliers, that comfort could be holding your profit margins back. Be sure to periodically shop around to find out if your pricing is still competitive. Competing offers may give you a reason to switch suppliers or negotiate down your current pricing.

Additionally, check into the payment terms with your current suppliers to see if they could be set up in a way that works better with your cash inflows. For example, perhaps you could align your payment due dates with dates that you plan to receive payments. In some cases, an accounts payable software can help you keep track of all these details and manage incoming and outgoing payments more effectively.

4. Keep Inventory Lean

Buying too much inventory, or too much of the wrong inventory, can quickly cause cash flow problems. Being so, it’s important to strike the right balance to ensure your supply aligns with your business needs. Buy more of what’s selling and figure out how much to keep on the shelves so you’re not under or over stocked. Also, be sure to identify the items that aren’t selling well and discount them when necessary so your revenue isn’t tied up for too long on the shelf.

5. Consider Your Financing Options

Another strategy to consider when trying to avoid cash flow shortfalls is to look into business financing options from various financial institutions. While they will come with a cost, it may be less than you would otherwise spend or lose due to cash flow problems. You could consider a business credit card, a business loan or line of credit, invoice factoring, and more. Here’s a closer look at a few of the popular options:

• Business credit cards: Credit cards designed for businesses may or may not require a personal guarantee. These give you a certain credit line that you can use, pay off, and use again. You’ll only be required to make a minimum payment each month. However, you will be charged interest on any amount that carries over beyond a billing cycle. Plus, they can help you build business credit which opens up more borrowing opportunities in the future!
• Business loans: Business loans provide you with a lump sum upfront which you repay (plus interest and fees) over a set term. Many online lenders make it easy and convenient to get a business loan, and upon approval, will transfer funds to your bank account within a day or two. However, in most cases, approval depends on your personal credit score.
• Business lines of credit: Business lines of credit give you a credit line that you can access on an as-needed basis. It’s often available for a set period of time and you’re only charged interest on the funds you use. This can be a good solution for your business if you aren’t sure when you’ll need money or how much you’ll need. Once the draw period ends, you’ll begin the process of paying off any outstanding balance you have. Typically, only interest payments are due during the draw period.
• Invoice financing/factoring: Invoice financing and factoring enable businesses to get paid on their invoices right away, for a fee. This can help you close the gap on accounts receivable if you aren’t able to shorten the payment terms with your customers. However, it will come at a cost. Factoring involves selling your invoices to a company while financing involves borrowing against them. In either case, approval depends on the creditworthiness of your clients.

These are just a few of the most popular financing options for small businesses. You’ll need to weigh your options and analyze the costs to figure what makes sense for your business needs.

If one is a good fit, you can use it to provide working capital when you experience a negative cash flow situation, and then can pay it back when your money comes through. While it will come at a cost, business financing can be a way to bridge your cash flow until you can do so on your own.

Expert tip: It’s best to plan ahead and have competitively priced financing available when you need it. You don’t want to end up scrambling to get a loan when your cash falls short which can lead to overpaying or not getting the cash soon enough.

6. Create a Cash Flow Conscious Culture

A business’s attitude about cash flow management starts with its owner and trickles down. You can help to improve your company’s cash flow by speaking about its importance and making it known on all levels. Encourage leaders, managers, and employees to think like business owners, so the entire team is focused on maximizing revenue and minimizing expenditures whenever possible.

Overall, this kind of culture will help to drive the right behaviors and decisions from everyone who’s part of your team whether they are handling customer disputes, planning company events, or analyzing cash flow projections.

7. Build an Emergency Fund

Businesses of all sizes need to ensure that they have a sufficient cash buffer to improve their chances of survival. Just as how you might build an emergency fund worth 3 to 6 months of expenses as part of your personal finance strategy, you must employ the same financial prudence in your business finance.

The general rule for small businesses is also to maintain at least 3 to 6 months’ worth of operating expenses on hand. This is especially important for small businesses, startups, and solo entrepreneurs as they tend to have limited access to capital and fewer financial resources.

8. Use Technology to Help

Lastly, in today’s world, you’ll find no shortage of apps and software programs that can help you with various aspects of your cash flow management from bookkeeping and inventory optimization to cash flow forecasting and more.

For example, QuickBooks Online helps small business owners with financial management by tracking expenses, calculating taxes, monitoring sales, generating cash flow statements, and managing invoices all in one convenient program. Further, tools like Jira Service Management and Flowtrac help to streamline inventory auditing, control, and optimization along with purchase order management.

Cash flow management can be very involved, but you don’t have to handle it all manually. Let some of the advanced software on the market do the heavy lifting for you.

Cash Flow Management is Key to Business Longevity

Over the past decade, we’ve seen crisis situations that have not only created economic hardships for citizens but devastated small businesses on a large scale. However, by implementing cash flow management best practices like these, you can plan for the best while preparing for the worst. Then, if another crisis does hit which disrupts your regular cash flow, you’ll be better prepared to weather the storm.

About the author

Written by Jessica Walrack

Jessica Walrack is a personal and business finance writer who has written hundreds of articles over the past eight years about loans, insurance, banking, mortgages, credit cards, budgeting, and all things credit. Her work has appeared on Bankrate, The Simple Dollar, The Balance, MSN Money, and Supermoney, among other publications. Her love of a good number breakdown and passion for making complex concepts easy to understand makes writing about finance a natural fit.