Experienced entrepreneurs know navigating cash flow cycles is an art. Businesses go through natural, predictable ebbs and flows. Newer business owners, however, are unlikely to have large cash reserves, and one wrong turn can be detrimental.
That's why it's so important to have a cash flow management plan that empowers the business to maintain long-term health, which requires careful planning. The following three steps provide a guide to navigating this seemingly daunting maze:
Step 1: Don't take on more debt than your business can handle
David Donovan, owner of Shaolin Martial Arts, in Peoria, AZ, started his academy on a shoestring budget with a loan from his father-in-law. It was just enough to open the doors. At the time, Donovan was unable to pay for training equipment, office supplies or uniforms.
"With no one willing to take a chance on me with a small business loan or even a credit card, I had to rely on pure cash flow to build the business," says Donovan.
In Donovan's industry, cash flow fluctuates drastically with seasons. As a result, Donovan has learned to put systems in place to sustain growth and carefully manage his transactions.
"Don't get sucked into more debt than you can handle," says Donovan. "It's understandable that an entrepreneur may need to use a credit card to open his or her dream business, but keep the loans small. Build as much of the company as you can from cash."
That means growing only as quickly as cash flow allows. To maximize his cash-based growth, Donovan takes care to protect his business from risk and utilizes promotions to infuse the academy with occasional bursts of new revenue.
Step 2: Analyze operations
Cash flow is closely tied to a business's internal operations. It is important for business owners to monitor trends and analyze their products and services regularly.
Mark Daoust, owner at Quiet Light Brokerage, specializes in helping small and medium-sized businesses prepare, market and complete the sale of their websites. He has identified a common pain point among his clients: inventory management.
"With e-commerce businesses, I often see small business owners take on too much inventory at the expense of cash flow," says Daoust. "I worked with one specific client who had annual profits of roughly $60,000 per year; however, he had inventory values of close to $200,000 at cost." After analyzing this merchant's inventory, Daoust found that a surplus of inventory that was more than two years old.
"The merchant's rationale was that he wanted to offer the widest selection of products in his industry," says Daoust. "But it was costing him significantly to do so."
Daoust encourages business owners to consistently analyze their products, inventory and services for cash flow red flags, such as paying to store unprofitable inventory.
Step 3: Scale steadily
Daoust encourages business owners to grow their businesses in a series of steps, never letting costs outpace financial responsibilities. This process begins with rigorous accounting.
"This is the top area that people either ignore entirely or give too little attention to. Your financials are your business's ultimate metric," says Daoust. "Keep them clean and well organized, and look at them to find areas of incremental improvement."
Businesses can use their financial records to forecast areas of opportunity — as well as potential risks and weaknesses.
"Many business owners also sink money into unnecessary expenses," says Daoust. "Properly maintained financial records will give you a quick look at where you are spending your money. This will help you identify where you can eliminate unnecessary or overpriced expenses."
Using this data, business owners can identify areas in which to scale incrementally. This step-wise approach can help small businesses manage their cash flow while pushing their growth plans forward.
Business owners don't become expert cash flow managers overnight — both their skills and their companies will take time to build. A commitment to controlling debt, optimizing operations and smart, steady growth is, ultimately, the key to healthy cash flow.