The Small Business Administration (SBA) defines small businesses as businesses with fewer than 500 employees. As such, small businesses account for 99.7% of all businesses in the United States, employing nearly half of all U.S. workers.
Despite their vital role in the U.S. economy, most small businesses only hold a cash buffer large enough to support 27 days of their typical outflows, according to a JPMorgan Chase study. Cash reserves provide small businesses with liquidity, a resource to draw upon when times get tough and an easy way to pay employees, vendors and suppliers. In other words, cash reserves ensure a small business’ security. Even the top 25% of small businesses only have two months' worth of cash buffer. This means these small businesses are at risk in the event of a significant economic downturn or other disruption.
Cash is king, and as cash-flow management is a deciding factor in whether or not a business succeeds or fails, it is a critical factor for small businesses to get right. Even profitable businesses have gone bankrupt because of poor cash management. What is cash flow? It is the movement of funds in and out of a business.
As such, small business owners need to understand the cadence of their business. Do cash inflows (getting paid) time well enough with cash outflows (obligations around salaries, business rent, etc.)? Does the small business have enough cash on hand to meet its obligations?
Small business owners can do a cash-flow projection using a basic spreadsheet. The Small Business Administration recommends using SCORE’s cash-flow management spreadsheet. If cash inflows and outflows do not align, consider if it’s possible to renegotiate payment dates or improve cash flow in other ways.
There are a number of ways a small business can improve its cash flow, including:
Speeding up collecting receivables: There are several ways to speed up collections, including asking clients to make payments with depository transfer checks or providing discounts when customers pay their bills early. Alternatively, small businesses can sign up for a lockbox (which is a post office box that is serviced by a bank) and have their customers mail checks there so payments are processed more quickly. Send invoices out immediately.
Taking advantage of credit cards' extra float time and rewards: This can help a small business earn rewards or cash back while also providing extra float time on when the cash actually leaves the company’s bank account. In many situations, it allows businesses to tap early-payment discounts with vendors and use their cash in the ways that make the most sense for them.
Conducting a credit check: If the customer doesn’t want to pay cash upfront, consider conducting a credit check. As a small business owner, it can be helpful to know if the customer/other company has the ability to pay. If their credit is poor, it is doubtful they will pay on time.
Opening up a High-Interest Savings Account: This can help a small business grow its cash position without doing anything too complicated or special.
To sum it all up, planning strategically for optimal cash flow is critical to a small business’ success. The small business owner who takes the time to plan out and predict cash flow each month will end up ahead.