Cash is essential for starting, running, and expanding your small business. Yet, many entrepreneurs have trouble managing and maintaining cash flow. In fact, according to a 2019 survey by QuickBooks, 60% of small business owners have experienced a cash flow issue at some point.
While financial challenges are a fact of life for many small business owners, you could be making missteps that are sabotaging your business. Stay on track by keeping your eyes peeled for these seven common cash flow mistakes.
1. Getting Too Ambitious About Future Sales
Forecasting future sales is tough. But if you’re basing your cash flow projections on overly optimistic revenue figures, you can quickly find yourself spending more than the business brings in.
When creating your sales projections, consider historical data from your own business or market trends for other businesses in the industry. Solid data can help you develop more realistic sales projections, so you can better understand how much you can spend without running out of cash.
2. Not Making Cash Flow Projections
Many small business owners make sales projections, but creating cash flow projections is just as important. A cash flow projection provides a clear picture of when money will come into your business, when it will go out, and how much you’ll be left with at the end of each month.
To build a cash flow projection:
- Select your horizon. You may want to plan for a few weeks or a few months, depending on how far ahead you can accurately predict sales and expenses.
- List all sources of cash. For each week or month, add all the cash you expect to come in from sales and non-sales sources, such as tax refunds or contributions from owners.
- List all uses of cash. For each week or month, subtract all the cash you expect to go out, including rent payments, payroll, purchasing inventory and supplies, loan payments and other operating expenses.
- Calculate your running cash flow. For each week or month, subtract your total uses of cash from your total sources of cash to see whether you can expect a positive cash flow or negative cash flow.
Using a cash flow forecast template makes this process a lot easier and helps you plan ahead for potential shortfalls.
3. Not Maintaining a Solid Cash Reserve
A cash reserve is essentially an emergency fund for your business. You can use it to cover unplanned, short-term financial shortages instead of taking on debt.
Most experts recommend keeping at least three to six months’ worth of operating expenses in cash reserves, although that figure depends on your unique situation. For example, if you could provide your business with a personal loan to cover a temporary cash shortage, you may feel comfortable with lower cash reserves. On the other hand, if your business is in growth mode and needs large investments in equipment, inventory, or personnel, you may need financing.
4. Ignoring Accounts Receivable
Slow-paying clients can be a major source of cash flow problems. If your clients regularly take 60, 90, or 120 days to pay for the goods or services you provide, you’ll quickly find yourself struggling to pay vendors, employees, and yourself.
Have procedures in place to deal with receivables. Some best practices include:
- Put payment terms in writing before selling to customers on credit
- Send invoices as soon as you deliver the product or service
- Make sure your invoice clearly states when payment is due and offers convenient payment options
- Send invoice reminders to ensure customers remember to pay
5. Playing Fast and Loose With Start-up Costs
Many entrepreneurs fall into the trap of “spending money to make money.” While the old saying has an element of truth, overspending without planning can lead to serious cash flow issues.
Before spending money on posh office space, high-tech computers and software subscriptions, expensive marketing campaigns, or top-tier talent, do a cost-benefit analysis. Ensure the expense will support your business’s profitability in a measurable way — don’t squander cash on anything that doesn’t.
6. Using Sales or Payroll Tax Funds To Cover Shortages
Imagine this: you’re facing a short-term cash shortage, but you have thousands of dollars sitting in another bank account. Should you use it? Not if that account holds sales tax collected from customers or payroll taxes withheld from employee wages. These amounts are known as trust fund taxes, which means they’re legally the property of the state or federal government.
When you’re short on cash, it may be tempting to “borrow” from these funds, but it’s simply not worth the risk. If for some reason you’re not able to replace the money before you need to pay the government, you could face penalties. The IRS can even hold the business owner personally liable for any unpaid trust fund taxes if they can’t be recovered from the business.
In the end, you could end up paying a lot more than you would if you’d simply taken out a loan or line of credit. Avoid temptation by depositing trust fund taxes in a separate account and never tapping those funds to cover shortages.
7. Not Applying for a Line of Credit When Times Are Good
You may have every intention of saving for a rainy day, but cash flow problems can come on suddenly. For that reason, it’s a good idea to establish a business line of credit with your bank or credit union when business is good, so you have short-term financing available in the lean times.
Don’t wait until you have a cash flow problem. This not only puts extra stress on you, but it can also make it harder to get financing when you need it most.
Most small business owners experience cash flow troubles from time to time. Familiarizing yourself with cash flow management best practices and avoiding these common mistakes may not prevent all issues, but it will help shortfalls occur less frequently and make them easier to overcome.