The SME Business Owner’s Guide to Cash Flow Management

What is cash flow management?

Simply put, cash flow refers to money that is being transferred in and out of your business. Cash flow management is thus the process of tracking and analysing how much money is coming into and going out of your business. This enables business owners to estimate how much cash they will have at any point in time, create cash inflow and outflow projections and assess when a positive or negative cash flow could occur.

Don’t mistake profitability for cash flow

There are core metrics that every small business owner should monitor, such as the operating margin, cash burn rate, cash flow and net profit. Among these metrics, associating cash flow with profitability is a common area of confusion, particularly for new business owners. It’s important to keep in mind that these are two distinct financial parameters - and it’s not uncommon for small businesses to be in the situation where cash flow and profits are at odds with one another. You can be cash flow positive without being profitable, or be profitable but still be cash flow negative.

Why is cash flow management important for small business owners?

• Cash flow is the lifeblood of any small business: As we’ve mentioned above, small businesses can find themselves in the situation where they are profitable, yet have negative cash flow. While this may happen occasionally, even profitable companies can run into trouble if having negative cash flow becomes a regular occurence. For example, while you may be able to land new contracts, you won’t be able to fulfil the agreement if you aren’t first able to meet your short term financial obligations, such as payroll or rental expenses. Over time, missing out on these opportunities will eventually result in significant losses for your venture.
• Proper cash flow management is vital for the long term growth of your business: Cash flow constraints can have far-reaching impacts on the growth of your venture. In an SGSME article, Dev Dhiman, managing director, Southeast Asia & Emerging Markets for Experian advised that cash flow challenges “have the potential to hold back the growth strategies SMEs intend to pursue during the next 12 months.” Rigorous management of your cash flow is crucial in order to work your way towards positive cash flow - where you’ll be in a position to invest in long term, strategic initiatives, instead of implementing shorter term, reactive measures.
• You’ll be better positioned to capitalise on unexpected business opportunities: Careful cash flow management will enable you to build up a cash buffer, or be better positioned to obtain external financing when you require additional funds to capitalise on unexpected business opportunities that arise. That’s because the strength of your cash flow is one of the key factors that lenders will look at when assessing your business loan application. To increase your chances of getting approved, you’ll need to show that you have a healthy cash flow, and are able to meet your payments in a timely manner even when unforeseen expenses crop up.

Common causes of cash flow challenges faced by small businesses

• Late payments: Delayed payments are one of the biggest financial challenges for SMEs in Singapore. According to findings from DP Info’s 2017 SME Development Survey, the percentage of SMEs facing financial challenges increased from 22 percent in 2016 to 35 percent in 2017. Of these companies, the majority (81 percent) were dealing with late payments from their customers.
• Lack of financial literacy: The lack of a background in business finance can make it challenging for business owners to prioritise record keeping and financial planning - particularly in the earlier stages of running their venture, when they need to wear many hats and juggle multiple responsibilities.
• Overestimating sales: Evaluating the potential sales of your company can be tricky - especially for new business owners, as they won’t yet have historical sales figures to draw insights from in order to make more accurate sales projections. These owners run the risk of creating an overly optimistic revenue forecast, which can lead to overspending and cash flow problems.
• Not keeping a cash cushion: Equipment breakdowns, maintenance repairs and a lower-than-expected sales volume are examples of unforeseen circumstances that may crop up from time to time, and create a cash flow crunch for your company if you haven’t built up a cash cushion. While what’s considered a sufficient cash reserve will differ across businesses, a general guideline is to set aside a sum that amounts to three to six months’ worth of your operating expenses. It’s best to consult your financial advisor or accountant to determine the exact sum you need to set aside.

5 Strategies to better cash flow management

Many small business owners struggle with keeping their cash flow on an even keel. Below, we’ll delve into five strategies you can implement to improve your cash flow, and get it back on track.

1. Stay on top of your accounts receivable

With tardy payments being one of the biggest financial challenges for SMEs, we can’t emphasise enough about the importance of staying on top of your accounts receivable, so as to minimise delays in receiving your payments. The following are action steps you can implement:Follow invoicing best practicesEven minor invoicing mistakes, such as not providing a detailed description for a line item can result in invoice disputes - and subsequently cause payment delays. To speed up customer payments, here are invoicing best practices you need to have in place:

• Don’t leave out the details: Invoices with unclear descriptions or incomplete information will require additional clarification and communication, which further delays the time that you’ll receive your payment. Before you send out an invoice, ensure that all necessary details are included. Be sure to provide a detailed description for each line item on your invoice. And if you’re sending through an invoice for a partial payment, make sure that you’ve outlined the services that you’ve completed, as well as the remaining balance that needs to be paid.
• Be prompt with follow-ups: Setting up invoice reminders is a simple way to make sure that you’re timely with following up on delayed payments. If you fail to receive a response, don’t be afraid to send through an email or make a phone call to remind your customers, and let them know that you expect to be paid on time. You may consider implementing a penalty to discourage late payments.
• Keep it simple: When it comes to your invoice design, it’s best to keep it simple and uncomplicated. Opt for a design with a clean background, simple layout and where your logo and contact information are clearly displayed.
• Consider shortening your payment terms: Reduce your use of net 30 or 60 payment terms where possible. Another way to encourage your customers to make their payments sooner is to offer a discount for early payments.

Protect your cash flow through milestone payments and depositsIf you’re working to fulfil a large order, consider requesting for a deposit of at least half of the total amount to be invoiced. With extended projects, it can be helpful to structure your payments by milestones, rather than receiving a final payment at the end of the project. In doing so, you’ll avoid running into dangerous cash flow situations - such as when you’ve covered the costs for a large order, yet are left waiting on late payments. Tap into external financing solutions to turn outstanding invoices into cashExternal financing solutions like invoice factoring offers a way for businesses to free up capital that would otherwise be tied up in outstanding invoices for 30 days or longer. Depending on the factoring company, you could obtain funding as soon as within a day or two from your application - which makes this a great option if you’re in need of immediate funding.

2. Optimise your accounts payable

With the right strategies and proper planning of your payables, you’ll be able to maximise their potential, thereby keeping your cash flow healthy. The following are action steps you can take:Build positive relationships with vendors and suppliersFostering strong relationships with your vendors and suppliers can be key to ameliorating the problem of financing and tardy payments. According to My Toby Koh, group managing director of Ademco Security Group, it all “boils down to relationship-building”. He further elaborates: “We have built a relationship with a lot of our clients that makes it more of a partnership. Even if they tell me they need longer credit terms for whatever reason, I know they will pay me when the time comes. Planning becomes a lot easier.”To foster strong business relationships with your vendors, here are some pointers to keep in mind:

• Be timely with payments: No business owner likes to be left waiting on late payments - so once you’ve finalised the payment terms, make sure you stick to the agreement and are timely in meeting your payments. If you foresee that you may have problems making your payments on time, be proactive in reaching out to your suppliers as early as possible to work out a solution.
• Add a personal touch: Take the time to get to know your suppliers - get in touch via a phone conversation, visit their offices, connect through lunch or coffee meetings and invite them to your company events.
• Maintain effective communication: Clear, open communication is key for building a healthy business relationship. Keep your supplier updated with the ongoings of your company, highlight any issues or areas of concerns as soon as possible and ensure that both parties fully understand each other’s expectations.

Take full advantage of payment termsIf your supplier has extended a net 30 or 60 contract, do make full use of it. Taking advantage of creditor payment terms will enable you to keep cash in your company longer, leaving you with more cash on hand to cover business expenses like payroll and rent. Categorise your paymentsConsider grouping your payments together into different spending categories, such as rent, taxes, insurance, operating expenses, miscellaneous expenses and more. There are two benefits to categorising your payments - firstly, you’ll gain a better understanding into how different groups of expenses add value to your business, so you can reduce or eliminate categories that don’t create significant benefits. Secondly, it’ll enable you to be more strategic with timing your payments. Ask yourself: “Which of my payments are vital for my business operations, and which are payments that I can afford to delay?” While you’ll need to be timely with paying out rent and payroll, other expenses, such as sales bonuses may be deferred for a reasonable period of time.  

3. Keep a close watch on your cash flow

In an Inc.com article, keynote speaker and author Jim Schleckser wrote that the most important tip he had for first-time entrepreneurs was: don’t run out of money. While the advice may be seemingly obvious, it’s a factor that’s often overlooked by many business owners. Schleckser explains that entrepreneurs have a tendency of looking at their P&L first - yet he emphasises that they need to pay as much, if not more attention to their cash flow statement. So if you don’t yet have a process in place for monitoring your cash flow, here are some suggestions to get started:

• Be rigorous about updating your cash flow: Blaine Bertsch, CEO of financial forecasting tool Dryrun suggests that small business owners update their cash flow projections “every time something happens in their business that affects their cash flow”. That means making an update whenever there is new information - such as when you’re making a payment, or when a customer tells you that a payment will be coming in late. It’s key that you have a system in place for managing your cash flow - whether that’s a simple excel spreadsheet, or a financial tool like Dryrun or Xero.  
• Carry out an in-depth analysis on a monthly basis: On top of reviewing your cash flow on a weekly basis, you’ll need to set aside a block of time each month for an in-depth assessment of your cash flow. During the review, you’ll want to assess your overall financial position, and look ahead at your cash flow projection for the next quarter.
• Share your cash flow plan with your team to get everyone on the same page: Get your team involved in your monthly cash flow reviews; this ensures that everyone is kept on the same page, which can help reduce unnecessary expenses and cash flow mismanagement.

4. Avoid expanding too quickly

While striving for growth, it’s important that small business owners understand their limitations - so that they don’t wind up expanding too quickly beyond their capabilities, thereby creating pressure on their cash flow. This typically happens when a company is left waiting on late payments, or are collecting smaller payments from older projects - while simultaneously doling out payments to cover the costs of financing new projects of a larger scale. It’s a problem that entrepreneur Tim Berry has encountered. In an Entrepreneur.com piece, he shared: “One of the toughest years my company had was when we doubled sales and almost went broke. We were building things two months in advance and getting the money from sales six months late. Add growth to that and it can be like a Trojan horse, hiding a problem inside a solution. Yes, of course you want to grow; we all want to grow our businesses. But be careful because growth costs cash. It’s a matter of working capital. The faster you grow, the more financing you need.”

5. Secure a line of credit before you need it

A business line of credit is a handy tool you can tap for better cash flow management: it serves as a cash cushion for unforeseen expenses, and aids seasonal businesses in balancing out their cash flow across peak and lull periods.When it comes to making your loan application, remember this: timing your application right is key. Ideally, you should apply for a line of credit when you don’t need it, as this leaves you with ample time to look around for a financing solution with favourable loan terms. If your credit profile isn’t in great shape, you’ll also have sufficient time to take steps towards building up your credit score, so you can qualify for better loan terms or a wider range of solutions when you submit your application.