Cash Flow: What it Is, How to Measure it, How to Fix it…

Cash flow is one of the most important things for small business owners to master. Here’s how…

Cash flow is one of the most fundamental concepts to master when running a small business. This article is a comprehensive guide that covers:

• What cash flow is
• Why cash flow so important,
• How we measure cash flow

We also get into some of the most common causes of cash flow problems and – most importantly – how to solve cash flow problems. One key to understand is that there are short, medium and long-term solutions.

You’ll learn how important it is to focus on the medium and long-term solutions rather than get stuck in a “quick fix” loop that sets you up to fail long term. Read on!

What is Cash Flow?

Cash flow is a very simple concept. You probably already understand it as it’s something that impacts personal finances as much as business finances.

Basically, cash flow is the total amount of money moving in and out of a business, especially as it affects liquidity.

The “movement” of money is the essential part here; tracking both:

• What’s coming in (from your sales)
• What’s going out (all your expenses)

You’ll probably remember a time (perhaps from your college or early career) when you ran out of money before a pay check was due and lived off ramen noodles. It was easy to see the cash flow problem then because it was unlikely there was much credit available to you.

Now, we have all kinds of ways of solving cash flow problems… dipping into credit cards etc. (more on that later) So it’s easier to ignore cash flow problems. But that doesn’t make cash flow less of a problem. Simply put: Your business will never achieve profitability if you’re always caught in cash flow problems.

Why Cash Flow Is So Important for Your Small Business

The risk of your small business failing is a real one. 30% of small businesses fail in their first 5 years. And for 82% of the businesses that fail, cash flow is the reason.

Those are some frightening stats. But they should also motivate you in the right direction. The good news is that cash flow is something you absolutely can master.

You don’t need to be a CFO to master cash flow. But you do need to have good visibility into your finances, both coming and going. Suffice to say you’re not going to master cash flow with your head in the sand.

But if you’ve got this far in the article, you likely already understand that. So let’s get on with the important stuff.

Do You Have a Cash Flow Problem? How to Measure Cash Flow…

If your expenses exceed your cash, then you have a cash flow problem.

If you want to go deeper, here’s a more detailed calculation:

Some meanings from this calculation:

• Cash from operating expenses: Cash generated or used to run the day-to-day operations of your business.
• Cash from investing activities: This is cash either earned or spent on investments (like securities, bonds, equipment, or other fixed assets and from the sale of these types of assets
• Cash from financing activities: Cash generated from a loan or investment or payments made here (like dividends or pay distributions to owners)
• Beginning cash balance: The cash you started the time period with
• Ending cash balance: If this is negative, you have a cash flow problem

Let’s work through a very simple example. Here’s a cash flow calculation for a month in a small business as a freelance writer:

If it isn’t obvious from the above, I’m keeping my head above water, which is good. I don’t carry a whole lot of expenses. But one major unexpected invoice, or losing a client suddenly, could tip me into a negative ending cash.

To help mitigate against this, it’s good to understand the things that can cause cash flow problems so that you can future-proof yourself.

The Major Causes of Cash Flow Problems

(1)  Slow / Seasonal Business

It’s important to understand that while expenses can be steady (monthly utility bills, payroll costs etc.), when running a small business income is much more variable than when you’re regularly employed. 

It can be feast or famine with clients. And there might be slower or busier months of the year depending on the nature of your business (that’s why learning to manage your time is key).

It’s important to keep an eye on your client pipeline to ensure you secure the minimum work you need to stay afloat. If your business is truly seasonal, think about shutting down completely during your off season.

(2)  Outstanding Invoices / Bad Debts

You can see I’m experiencing this in the example above: One of my clients is holding $2000 hostage. It’s didn’t break the bank this month but if more clients followed suit it could become more problematic.

Keeping track of your outstanding invoices is crucial for cash flow. You don’t want to realize “too late” that you’ve got bad clients breaking your cash flow.

(3)  Big Expenses / Excess Inventory

Did you make a mistake by buying more of something than you needed (inventory is a good example if you’re in retail sales)?

Or perhaps you simply had a month of bigger expenses. “Everything blew up at once” is a common problem in life… You know, all of a sudden both your laptop, printer and phone implode and you’re forking out for replacements you didn’t plan for.

(4)  Rapid Growth

Your business can also experience bigger expenses for exciting reasons:

Maybe you land HUGE client for an exciting project and you’ve got to invest in a big piece of software or take on additional contractors. It could be an exciting time for you and your business… and yet it can put a stress on cash flow.

Perhaps you’re going through a period of real growth that involves hiring additional staff. This rapid growth might hit your expenses before it shows up as income too.

Big marketing spends can count here too. Sometimes you have to spend money to make money and especially when you’re scaling your business you might invest in more brand and marketing activities that eat into your immediate cash.

(5)  Lack of Financial Tracking / Forecasting

We talked earlier about burying your head in the sand. A lot of freelancers and solopreneurs make mistakes that prevent them having visibility into cash flow. These can include:

• Not separating personal and business finances
• Not tracking and categorizing expenses accurately
• Not understanding the seasonal trends in their business and sort of “coasting”

Clearly, the starting point for a healthy conversation about cash flow is tracking it. Hopefully the calculations above have inspired you to track your own cash flow, if you’re not already.

(6)  Tax Bills

It’s easy to forget about Uncle Sam until the end of the quarter or tax year and then find yourself carrying debt from tax. As you can see from our working example, I’m quite diligent about setting aside money for taxes.

As you set money aside, you can decide whether to:

1. Invest that money until the bill is due (make some money off your tax and keep it in your pocket longer), or 
2. Pay taxes in installments (removes any temptation to spend, but probably less savvy from a maximum gains standpoint).

(7)  Low Margins / Wrong Pricing Strategy / Underselling Yourself

If you’re undercharging clients, giving away work for free or simply not considering the costs of producing the work you need to make, you could suffer cash flow problems even if you’re managing your expenses well.

Obviously your cash flow statement starts with income and that starts with pricing. Competitive pricing is key to getting business… especially early in your business. But underselling yourself is a lose/lose situation for cash flow.

On a more ethical note: It’s not good for your industry when there are people undervaluing the work. It creates a bad economy. Never feel guilty about charging your worth!

Cash Flow Solutions: Short Term Fixes

These solutions are for those months when you’re in a real pinch. You’ve got a cash flow problem that’s immediate and pressing (that tax bill is due, e.g.) The number one priority is drumming up some cash to stay afloat.

Please note and read the next section about the risks of some of these short term fixes… some should only be used as an absolute last resort:

(1)  Run a Flash Sale / “Sell, Sell, Sell”

Obviously increasing income is a quick way to help cash flow. This can mean offering discounted products or offers to clients. 

It can also mean taking on more work than you can reasonably handle (working all hours). If these tactics attract more business, you’ll get an extra income injection into your business.

(2)  Switch from Check to Electronic Payments / ACH / Credit Card

Perhaps you – like our example – have some outstanding invoices. Or maybe you’re finding waiting for checks to clear is causing some “awkward” cash flow moments.

Changing your payment method to electronic payments (like ACH, credit card) may incur extra fees, but it can also get money in your pocket 3-4 times faster. This is because it’s simply more convenient for your clients to pay online.

Making this switch is something you can do immediately with the right invoicing software.

(3)   Negotiate with Creditors

If you owe money (bank loans, credit cards, other invoices you have to pay) you can reach out to creditors to renegotiate payment terms. E.g. if an invoice on your desk is Net 10, you can ask for Net 30.

Many say it’s a good tactic to negotiate interest rates with banks, telecommunication companies etc. on a regular basis and this is actually a savvy thing to do to ensure you’re not being overcharged, especially by those kinds of enterprise businesses.

(4)   Invoice Factoring / Invoice Financing

There are many different services that will offer to give you cash up front for your unpaid invoicing. These are similar to pay day loans.

It’s very important to be completely clear about the terms you’re agreeing to if you avail of these kinds of services. Clearly, they’re going to take a cut.

(5)   Tap a Line of Credit

Finally, there are other short term financing options for small business owners. These include:

• Credit Cards
• Business Bridge Loans
• Business Tax Debt Loans
• Daily Payment Loans
• Merchant Cash Advances

Many of us in both personal and business financing take advantage of loans and credit cards. So we’re not here to tell you these are *bad* solutions. However, just as in personal finance, there’s a difference between taking a loan to make an investment purchase and taking a loan because you’ve mismanaged finances. And there are better and worse loans out there.

*IMPORTANT* Risks of Short-Term Cash Flow Solutions

You probably picked up the note of caution in some of the sections above, but it’s not fair to say any of these approaches to fixing short term cash flow problems are inherently *bad*.

That said, there are some risks worth working through before you leap to some of these solutions. Good questions to ask yourself:

(1)  Does this Short-Term Fix Set Me Up to Repeat?

How will next month be different? Am I putting myself in a deeper hole that will make next month even harder to dig out of? If that’s the case… maybe they’re not the best approach.

This isn’t just about money, it’s also about your ability to sustain the approach. For example, if you adopt tactic 1 of taking on more work, how will you ensure that you don’t need to do this again next month. Otherwise, you risk burning out.

(2)  Am I Incurring New Expenses With These Approaches?

The sources of credit listed as options (4) and (5) above also come with their own costs. It’s important to be aware that you’re setting yourself up with that extra expense, and for how long.

For example, loans and credit cards come with repayments and interest. More expenses mean more strain on your cash flow in the future. That might be acceptable… but go in with your eyes wide open.

Cash Flow Solutions: Medium Term Fixes

The medium term cash flow fixes are much more about sustainable practices that set you up for success on an ongoing basis. Even if you’re not experiencing cash flow problems today, these form a good checklist to future-proof your cash flow. Let’s take a look!

(1)  Act Swiftly & Automate Follow Up on Outstanding Invoices

Sitting too long on outstanding invoices makes it more likely that you’ll never get paid. In fact, 71% of freelancers struggle to get paid. You need a process to ensure you stay on top of unpaid invoices quickly and consistently.

This is something many small owners dread. They don’t want to have those awkward conversations. That’s where invoicing software can help. You can automate following up on unpaid invoices at regular intervals.

How and when you invoice has a HUGE impact on your cash flow. As a short term tactic, we advised changing your payment method to an electronic one. In general, we also advise:

•  Sending invoices immediately: There’s absolutely no reason to wait until end of month, or later. The day the work is completed and delivered, you can whip off an invoice to the client. Odds are that momentum will make them pay it more promptly too.

• Choosing better payment terms including late fees: The terms you set for your invoices really impact how fast you’ll get paid. You can add late fees to unpaid invoices as an additional incentive. Click here to learn more about payment terms here.

(2)  Increase Prices

Obviously it’s not a good practice to jack your prices willy-nilly (especially with valuable long-term customers). But you should also regularly review your pricing to make sure you’re charging what your worth.

Key reasons to increase your prices include:

• You learn competitors are charging significantly more
• You’re landing more business than you can serve
• Your experience / portfolio has grown substantially
• You find you’re constantly under-scoping/overdelivering to your clients
• The market for your services changes

It’s up to you to decide how to roll-out and communicate a price increase. You might start with new clients only. In general, it’s a better practice to review and adjust pricing annually rather than suddenly jack prices by a hugely significant amount.

(3)  Ask for a Deposit / Work on Retainer / Installments

Asking for a deposit up front helps inject some income earlier into the project rather than waiting until the work in complete to get paid.

This is a good practice on a big project that will take many months. For example, if you’re in construction, for example, a project might span many months and a deposit will give you two things:

• Confidence in the client and their ability to pay
• An injection of cash up front for any expenses the project will incur

Working on a monthly retainer of installment payments at key milestones of a project is another approach that will mean more steady income over the course of a long-term project.

Imagine I’m writing a book for a client. I could say, it’ll cost $25,000 and wait for that big payday once the final project is delivered. Or I could provide an estimate that breaks the project into key milestones, like this:

*Based on scope discussed. Additional requests will be subject to additional costs.

Exciting as $25000 lump sum check sounds, I know I’d choose to collect the payments as I go. That way if the project (for any reason) goes belly-up, at least I’ve been paid for the work that’s already done and delivered.

(4)  Reduce Expenses / Cut the Fat

Another good practice and regular habit is to review your expenses and consider do you really need them.

Good examples of expenses to cut:

• Subscriptions and memberships you don’t use: Do you ever read those magazines, go to those meet-ups? If not, shut them down
• Software expenses that can be consolidated or downgraded to a freemium version: You might have thought you needed the Premium service but now you’re realizing a lighter will suffice 
• Office space costs you don’t need: Do you really need your office? Is there a cheaper alternative?
• Staff that isn’t performing or showing a good ROI: It’s hard to let people go, but headcount is a huge expense. Be willing to make those tough decisions.
• Travel and entertainment costs that aren’t necessary: Are you wining and dining more than you need to? Jumping on planes to meet clients when teleconferencing would work? Cut those costs!

Note: Good businesses incur expenses. Your goal shouldn’t be to eliminate expenses. Nobody wants to work for Scrooge. Remember that your business and your values are intertwined. This isn’t about being miserly… it’s about building a sustainable business. You probably don’t need to take away the water cooler or coffee machine to do that 😉

Cash Flow Solutions: Long Term Fixes

(1)   Create & Use a Business Budget

With so many moving parts, it should be clear by now that a monthly snapshot is not “big picture” enough to truly master cash flow.

You need to:

•  Understand the seasonality of your business
• Plan for bigger or growing expenses, like additional equipment and headcount
• Business case any strategies to grow your business, like marketing campaigns
• Regularly review your pricing strategy
• Review and strategize how to best package your services
• Survey the market and hopefully up-level your clients

This is why it’s important to take a step back from day-to-day, or even month-to-month operations and coming up with a business plan and budget.

It will be difficult to do this, say, in your first year of business when you’re still learning a lot. But try to not just “wing it” even at the beginning.

(2)  Track Your Finances 

Even if you don’t have a budget, track what’s happening in your business. There’s absolutely no excuse these days for tucking expense receipts in a shoe-box or blurring your personal and business expenses.

Most invoicing software also helps you track expenses and do basic accounting. You should have clear visibility into where your business stands all the time. If you’re reading this and your business performance is a mystery to you, you’re much more likely to end up with cash flow problems.

Now, this won’t help solve any cash flow problems you have today. But it will set you up to not repeat those mistakes again. Don’t wait to start tracking your business’s financials.

(3)  Find & Work with Better Clients

The quality of your clients has such a huge impact on your cash flow health. The best clients bring you repeat business and pay you on time. (They also generally ask you to do more rewarding work and are more appreciative of your services).

Taking on more clients to desperately fix cash flow is a short term fix. But if those clients undervalue you, it will hurt again later.

Instead, dedicate your energy to building a steady roster of “anchor” clients who guarantee a certain sustainable income level. Also put a lot of energy to nurturing these relationships. 

Don’t hesitate to “fire” clients who aren’t reliable or good to work with. Just make sure you have a pipeline to replace them with somebody better!

(4)   Package Your Goods and Services Differently

If you offer different products and services it’s a really good idea to think about how you can “package” or “parcel” things to make more money.

For example, I consult on content strategy, write, teach and train others. If I’m clever about how I package those services together I can get clients to spend more money with me than perhaps they initially intended, or set myself up for repeat business in the future.

I can sell discount packages of say 10 blog posts, rather than just taking assignments one at a time.

How you package what you’re selling really influences your cash flow. Think of those apps you use that incentivize you to choose annual plans rather than paying monthly. That’s a major way of them getting more cash in their pockets sooner! Copy that tactic!

(5) Teach or Hire Staff to Be Better at Upsell and Cross-Selling

If you have people working with clients for you, they should be bringing a “sales” mentality to their relationships. You want them to push your product packages for you and be able to demonstrate the value of committing to long term relationships.

Some will initially feel uncomfortable doing this. It will feel too “salesy”. And this is where it’s essential that they believe in the products and services they’re selling too.

For example, a beauty therapist may recommend a course of facials and also some products to supplement your skincare routine. Yes, this is upselling and cross-selling. But if they actually believe it will make a difference to your skin (and if they believe in the products), it’s also just good customer service! 

Conclusion: Cash Flow Is a Problem You Can’t Afford to Have

If you’ve made it all the way to the end… congratulations. This was a monster read. We hope there was something for you whether:

• You’re just learning about cash flow for the first time, or
• You’re already pretty savvy but want to improve

Cash flow is almost deceptively simple as an idea. You can feel like you’re making loads of money but struggle to understand why your bank account is empty. Or maybe you’re doing fine but wonder if you could do even better!

Mastering cash flow is key to understanding and managing your business for profitability. And it’s something you can do following the steps outlined throughout this article. Good luck!