As a small business owner or start-up, cash flow is the lifeblood of your business. Mismanaging your cash flow can see your business run to the ground.
A crucial distinction that needs to be understood is that cash flow and profits are different from each other. Many start-up founders fall into the trap of thinking in profits but spending in cash. Profits are a calculation of the excess of revenue over your expenditure. Expenditure can consist of expenses in cash as well as representations of expenses incurred but not yet paid. Cash represents the actual amount of money that you have in your bank account. Profits are not always reflected by the amount of cash you have.
Therefore, cash flow represents the actual cash you have flowing into your business. Mismanagement could mean that you cannot run your business any longer. Now that you have a basic understanding of cash flow, let’s look at five errors in the realm of cash flows to avoid at all costs.
Mistake 1: Not budgeting start-up costs
Many people improperly estimate costs that they must incur in the start-up phase, that is before the business is even running. Some of these costs are rent, taxes, logo design, website design, and legal services. Fixed costs like insurance can be compared online through online insurance sellers, get the best insurance for your shop by clicking here.
Start-up costs are not universal, and it can be difficult to comprehensively estimate at the outset. Some people choose a haphazard approach to starting their business without estimation. While this may work in the short run, it is difficult to maintain. Estimating your cash needs in advance can help when canvassing investments or loans so that you can seek to maintain a cash reserve. The aim of properly estimating start-up costs is so that you can guard against the risk of shutting your doors before you even start the business.
Mistake 2: Over-estimating your profitability
Start-up founders often get attached to their idea and, even if it is revolutionary, it can take time and tenacity to reach profitability. You may think customers will be lining up at the door the day you start, but that may not be the case. A Kabbage survey found that 84% of businesses reach profitability only in the fourth year of business.
If you are not prepared for this, you could be headed for a cash flow rut early on. If you are estimating revenue too early on and without a reasonable basis, that is when you are over-estimating your profitability. Learn to estimate profitability objectively and with a reasonable timeframe. That will help you in setting aside enough cash reserve to tide you over until you become profitable.
Mistake 3: Flying budget-free for too long
There are uncertainties in business, but preparing a budget can help you deal with cash flow uncertainties. Cash flow budgeting will include both your sales and cash outgo. Looking at last year’s sales can help you get an idea of sales in the upcoming year. If sales were affected last year by a crisis or disaster, go into this exercise on a month-to-month basis and build from there.
Calculate the cost of your projected expenditure, including the cost of producing your goods or services and fixed expenditure. The cash flow budget should be a key document of your business. Make use of the cash flow budget to get an understanding of where your cash flows from and to. As we have discussed, cash expenditure does not always match the income statement expenditure. Keeping a cash flow budget will help you understand how much cash you will need and keep an adequate amount squirrelled away in your bank account. Once you understand how much you need, you may also be able to identify low-risk investments to park your money in instead of your bank account.
Mistake 4: Collecting receivables too late
Many businesses invoice their clients at one point and receive payment a long time after the invoice is made. It is a common business practice to provide a credit period. So, for most businesses, there will always be some amount of accounts receivables to collect. The problem is that, until your customer pays, you are without cash for your business. Most businesses get around this with working capital and good business management.
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If you find that you cannot run your business effectively, you need to look at why cash is short. Is it because too much of your cash and revenue is tied up in receivables to be collected? In that case, you may need to re-look at your invoicing terms and practices. Consider evaluating your receivables turnover ratio, i.e., net credit sales divided by average accounts receivable. If it is too low, that could be a sign you need to reassess your credit policies.
Mistake 5: Growing your business too quickly
Start-ups and small businesses are often advised to scale quickly but not off schedule. There is a difference between scaling and growing. Scaling your business involves putting in predictable processes to handle daily business tasks. Scale involves adding revenue at a fast rate while adding incremental resources. Growing your business means adding revenue at the same rate that you add resources.
Many small businesses fall into the trap of hiring too early or taking on expensive commitments before they know they can meet them. Spend the early days doing things yourself instead of hiring for every task. There are a lot of things you can learn to do. For example, if you need to make a YouTube thumbnail, you may not need to hire a graphic designer. Do your research and put in the work, and you may be able to get the job done yourself and save on cash outflows.
Healthy business means healthy cash flow
If you’re not making money, you’re not running a business. To have a successful business means to have a reliable cash flow. Avoid these cash flow errors to ensure your company stays healthy. Also read more news and stories to grow your business.