Small Business Cash Flow Basics: 13 Strategies to Improve Your Cash Flow

Healthy cash flow is one of the most important financial goals for maintaining your small business growth, but many small business owners don’t know much about it. In this guide, you’ll learn the cash flow basics – including what it is and why it’s so important for you and lenders – as well as strategies you can use to improve your business’s cash flow.

What is cash flow?

Simply put, “cash flow” is the money coming in and going out of your business. It’s the cornerstone of any successful small business because it demonstrates your ability to pay your financial obligations, invest in new opportunities, acquire financing, and grow and sustain your operations.

Within the basic concept of cash flow, there are also specific and important types of cash flow, and knowing these will help you better understand the cash flow basics:

1. Operating cash flow

For most small businesses, this is the most important type of cash flow. It represents the cash generated from or used by your business’s core operations. On the income side, operating cash flow includes cash from sales or services as well as other consistent forms of income. On the outflow side are expenses related to your core operations, like your inventory, staffing, marketing, and overhead.

For your business to break even, the cash coming in must be enough to cover expenses. For your business to be profitable, the cash inflow has to exceed ongoing expenses – this shows that your business generates enough cash from normal activities to sustain operations and create a profit.

2. Investing cash flow

Investing cash flow is the cash spent on and received from acquiring and selling long-term assets such as property, equipment, and investments. It demonstrates your business’s investment in future growth. For example, if you purchase commercial real estate for your business, you gain a tangible asset while also making a commitment to managing operational expenses.

Having a negative investing cash flow isn’t necessarily detrimental, as it could show investment in your business. Keep in mind that this should be balanced with your available resources – and your operating cash flow should support that.

3. Financing cash flow

This is the cash that comes in or goes out as a result of transactions with your owners or creditors. This includes loans, owner-equity infusions, dividends, and debt repayment. Financing cash flow shows how your business is funded and how you’re managing your capital structure. A positive financing cash flow usually demonstrates new investments or loans received, while a negative financing cash flow could represent debt repayment or distributions to owners.

Understanding your business’s cash flow rhythm through its operating, investing, and financing activities is essential for financial strength – and it will better position your business for financing if you need a loan or line of credit.

Why is cash flow important for your small business?

Your goal is to generate positive operational cash flow and demonstrate a reliable strategy regarding investing and financing cash flows. However, most businesses experience ebbs-and-flows in their cash flow – times when income is high, followed by times when income is strained. These cycles, while normal, can throw your business off balance and cause financial pressure if you’re not prepared for them.

The cycles can be seasonal – for example, a waterfront restaurant with a busy season in summer may close during the winter. The good news is that most businesses can predict some measure of cash flow cycling. There are ways you can boost positive cash flow and reduce financial strain to help you during your slow season.

How is cash flow calculated?

An operating cash flow formula to calculate your cash flow can be as simple as:

   Operating Revenue – Operating expenses = Operating cash flow

This is often referred to as the direct method to calculate cash flow. However, most accountants and other financial experts agree that the indirect formula is a more accurate assessment:

   Net income +/- Changes in assets and liabilities + Non-cash expenses = Operating cash flow

Annual cash flow is calculated by taking the net income earned by your business over a year and then adding back any non-cash expenses, like depreciation and amortization, plus interest paid on other existing debts. The formula is:

   Net income + Non-cash expenses + Interest paid on current debts = Annual cash flow

Then, this cash flow will be compared to the annual principal and interest payment requirements on all your current loans, as well as the loan you are requesting.

13 strategies to improve your cash flow

These strategies can help you improve your business’s cash flow position. Try them today and soon, you’ll have cash flow basics mastered.

Improve cash inflow

1. Optimize your pricing strategy: Evaluate your pricing strategy to ensure your products or services maintain or improve your profit margins without losing customers. Although it’s important to check your competitors, consider your options rather than solely competing on price.
   
2. Offer subscriptions or retainers: Implement subscription-based services or retainers to generate steady, predictable income. This can ensure you have recurring revenue and help prevent fall-off.
   
3. Focus on high-margin products or services: Prioritize the sales and marketing of your products or services with higher profit margins to improve your overall cash flow.
   
4. Diversify revenue streams: Develop multiple sources of income to reduce your reliance on a single customer or market. While this is important for all businesses, it can be a game-changer if your business is reliant on seasonal or cyclical income.
   
5. Strengthen your invoicing strategy: Use bookkeeping software like QuickBooks to implement faster – and more consistent – invoicing and follow-up processes so that you don’t fall behind on your accounts receivable. You could consider incentivizing early payments to encourage quicker turnaround.
   
6. Secure your access to funds: Having access to funds through a line of credit or a business loan can help you cover cash flow gaps and leverage opportunities.
   
7. Create a cash reserve: Build and maintain a cash reserve in case you encounter unexpected expenses or downturns.

Reduce expenses

1. Improve your inventory-management system: Find ways to manage your inventory better. For example, if you rely on “eyeball guestimates” for stock, commit to using a software program to track incoming and outgoing goods, returns, or damaged inventory. This will help you better track, manage, and stock with less waste and identify changes due to seasonality and customer preferences.
   
2. Negotiate better payment terms: Work with suppliers to see if they’ll extend payment terms that will give you more time to pay without straining your cash flow. You could also request an early-pay discount or other incentive.
   
3. Review your business’s budget regularly: As your business grows, it’s common to add expenses without reviewing the budget. Review yours regularly to identify areas where spending can be reduced, eliminated, or reallocated to improve cash flow.
   
4. Outsource non-core functions: Consider outsourcing some non-essential functions, such as payroll, technology, or human resources, to reduce your overhead and free up cash for core activities like sales and services.
   
5. Leverage technology: Implement cash flow management software or tools to track your income and expenses in real-time for quicker adjustments and better planning.
   
6. Consider leasing equipment instead of buying: Research whether it makes sense to lease equipment rather than purchasing it. For example, if your manufacturing business is in the early stages, you may be better off with leased equipment that you can exchange as you grow. Even office equipment, like color or specialty printers, can be less expensive to lease, given the technology changes and maintenance required.

Can a small business loan help improve your cash flow?

The right small business loan or line of credit can help you smooth out cash flow cycles and position your business to leverage opportunities while better managing expenses. For example, financing can help you hire sales or service staff to build revenue. Or you can use it for renovations and purchase equipment to reduce production costs and create process efficiencies. With a small business loan, you can improve cash flow and boost your bottom line.

What do lenders look at when considering your business’s cash flow?

Cash flow is a critical factor that lenders – including banks and community development financial institutions (CDFIs) – consider when evaluating loan applications. That’s because cash flow is a key sign of the financial health of your business. It’s a good idea to show potential lenders that you understand your business’s cash flow cycles and have identified ways a loan can improve your financial position.

Most lenders will use your most recent tax returns as a starting point for the cash flow calculation. They’ll also look at your business’s cash flow statement and other interim financials, such as your profit-and-loss statement and balance sheet.

When reviewing your business’s cash flow, lenders also consider:

• Consistency: Lenders want to see that your business consistently generates enough income to cover your core operating expenses and any existing debt obligations. However, they also recognize that small businesses experience ups and downs in cash flow as you launch and develop. A lender will also consider how you’re managing your business and how your loan request can help you address cash flow inconsistencies.

• Planning: Planning for cyclical fluctuations means that you understand your business and have taken steps to reduce uncertainty, which shows lenders that you’re more likely to manage debt responsibly.

• Repayment ability: Lenders look at whether your current cash flow is sufficient for operations and whether there’s enough financial room for additional debt to be repaid. If it isn’t, you need to demonstrate how a new loan will help you to better manage cash flow and leverage opportunities to improve profitability.

• Debt-service coverage ratio (DSCR): Lenders use this equation to determine whether your business has enough net operating income to pay back a loan. A simplified calculation is ‘net operating income divided by total debt service.’ A DSCR of 1.00 typically means that your business has just enough operating income to pay off its debt service costs. If it’s less than 1.00, this demonstrates a negative cash flow, while a DSCR over 1.00 shows that you have enough cash to meet your debt obligations.

• Default risk: Businesses with negative or inconsistent cash flow are at higher risk of missing payments, which increases your lender’s risk. On the other hand, strong cash flows reduce you and your lender’s overall risk.
  
• Collateral and guarantees: Lenders prefer that your business has enough cash flow and good financial management when considering a loan. However, depending on the lender and loan, having collateral and guarantees can help you overcome cash flow challenges.

• Operational efficiency: Good cash flow management shows you have efficient operations and controlled expenses. Lenders will see that your business has strong management, processes, and procedures.

Cash flow is key and Pursuit can help

When you develop a solid understanding of cash flow basics, you position your business for success. Still, even with strategies to better manage your income and expenses, most small businesses will need help smoothing out cash flow challenges from time to time.

Pursuit has small business loans and a line of credit that can help businesses located in New York, New Jersey, Pennsylvania, Connecticut, Illinois, Nevada, and Washington.

Take a look and contact us today – we’d love to learn more about your business and ways that we can help.