Cash flow is the life blood of every business. Without cash, it’s hard to purchase inventory, pay employees, and ultimately keep the doors open. Over the years, poor cash flow management has led to the demise of many small businesses. Read on to learn more about how to calculate your cash flow metric, and how to optimize your cash flow management.
What is cash flow?
Essentially, your cash flow is your current assets minus your current liabilities. Current assets are defined as things like your cash in the bank, your current Accounts Receivable, your inventory, your business location (if you own it), and any equipment or other asset you may have to facilitate doing business. Your liabilities are usually defined as your current Accounts Payable and any long-term payables you might have. A business loan, line of credit, or other business debt would be included in this number.
Basically, if your expenses exceed your income, then you have a cash flow problem. However, there is a specific calculation you can do to get a more detailed picture of your cash flow health: your cash flow metric.
How do I calculate my business cash flow metric?
If you’ve never heard of your cash flow metric before, it’s something you should get familiar with. If you divide the value of your current liabilities into your current assets, you’ll come up with a ratio of assets to liabilities. The ratio you’re shooting for should be to have twice as many assets as liabilities (or a 2:1 ratio).
Although this is difficult for many small business owners to achieve, any ratio below 1:1 indicates that it’s costing you more money to operate your business than you’re taking in and could be an indicator that there are real problems with your cash flow—even if you have cash in the bank at the end of the month.
How do I address a cash flow issue?
Here are a few ways you can address a business cash flow issue, beyond just bringing in more revenue:
Categorize your spending
Go through your business expenses with a fine tooth comb to get a better understanding of where you’re spending money. Then, break out your expenses into categories so you can see where your money is going. The most common categories business owners include are marketing, operations, sales expenses, and R&D. If you’re not sure of the best way to do this, your CPA or a capable bookkeeper should be able to help you determine the best way to categorize your business expenses. They will also be able to help you with some accepted rules of thumb for how much of your revenues should be devoted to each category.
Benchmark your spending
“You should have a clear picture of how other businesses are spending and use those benchmarks to spend similarly,” advises Flint. “Consider businesses within your industry as well as businesses within your company’s lifecycle stage.” The idea isn’t necessarily to mimic what other businesses are doing, but to take the opportunity to get a feel for where you should be vs. where you are and determine what’s right for your business. Here’s another place where you can consult with your accountant. I’m a big fan of making that relationship less transactional and more consultative.
Micromanage Your spending
Every dollar you spend is detracting from your profit margin, so it’s important to consider the cost-benefit of every single expense, especially when you’re just starting out. Look at places where you can cut back on expenses – for example, can you buy common business supplies in bulk and get a discount? Don’t forget to negotiate with your vendors for the best price possible as well – check out “The 3 Most Effective Ways to Leverage Vendor Discounts” for more tips. Having spent most of my career of nearly 40 years either working in a small business or operating a small business, I’ve really come to appreciate that how and where you spend your cash flow has a big impact on the success of your business. Controlling your expenses is a powerful way to impact your bottom line.
Once you have your expenses categorized, an idea of where it makes sense for your business to spend its valuable resources, and have tight controls on spending, you can make better-informed decisions regarding where and when to invest in growth initiatives, when borrowing could make sense, or when to simply stay the course.