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Cash Flow 101: A Guide for Small Business Owners

Cash flow is a vital indicator of stability and growth potential for a small business. Read on to understand how it impacts your access to capital.

A healthy cash flow is the lifeblood of every small business. 

In today’s economic environment, mention those two words, and you’ll see the blood drain from the faces of most small and medium-sized business (SMB) owners. 

This indicator of financial stability dictates your capacity to settle expenses, maintain day-to-day functions, and explore new growth strategies. A negative cash flow has the potential to impact relationships and erode trust, be it with vendors, suppliers, and even your employees. 

In today’s article, we will explore all things cash flow. Expect to learn what it is, why it matters, and how it could impact your ability to access additional capital to drive business growth. 

What Is Cash Flow?

Cash flow is the net movement of money in and out of your business at any time.

Let’s go back to the word we used in the introduction: lifeblood.  

Imagine your business as a beating heart. Blood flows into it, and the heart pumps it out to the rest of your body. This continuous, uninterrupted cycle of in-and-out ensures you stay healthy… and alive! Imagine the consequences if this flow is thrown off.  

While the heart is a zero-sum game, your business could always use a comfortable buffer of cash coming in vs. cash going out.  If more money flows into your business than out (e.g., sales, net income, deferred income tax, cash from long-term debt), it’s a positive cash flow. If more money moves out than flows into it, it’s a negative cash flow (e.g., paying suppliers, employee salaries, fixed asset purchases, among others). 

There are three types of cash flow that business owners need to know:

1. Operating

Operating cash flow represents the net cash inflow or outflow derived from core business activities like selling and purchasing inventory, providing services, and paying salaries. Your company can develop and expand if this cash flow is positive. 

2. Investing

Investing cash flow is the net cash movement resulting from your investment endeavors, including purchasing equipment and selling assets. 

If your business prioritizes growth, it channels resources toward that goal, and you have a negative investing cash flow. In this instance, “negative” isn’t necessarily a cause for concern: it reflects your intention to grow your SMB. Check out this article from Fool to see more examples of investing cash flow and how to calculate it. 

3. Financing 

Finally, financing cash flow represents the net cash exchanges between your business, investors, proprietors, or creditors. It encapsulates the cash flow activities related to financing operations, incorporating debt issuances, equity transactions, and dividend disbursements. Read this article from Indeed to learn what to include in your financing cash flow calculations.

Why Is Cash Flow Important?

Cash flow matters for many reasons, but its value can be succinctly explained in the following 10 words:

It ensures the smooth operation and sustainability of your business.

At its core, healthy cash flow enables small business owners to meet immediate financial obligations—such as paying vendors, employees, and rent—without delay. This is essential for maintaining trust and reliability among suppliers and staff and ensuring that a business can continue its day-to-day operations without interruption.

A consistent, positive cash flow also provides the foundation for strategic growth and resilience. It allows businesses to allocate funds for exploring growth opportunities, expanding operations, and investing in business development that can increase revenue streams.

Finally, and perhaps most importantly, effective cash flow management empowers small business owners with the agility to navigate unforeseen challenges, such as economic downturns, supply chain disruptions, or even a global pandemic (looking at you 2020).

In these scenarios, positive cash flow positions business owners to weather the storm without compromising their operational integrity. Be it an emergency fund or other type of financial buffer, cash flow acts as a crucial strategic asset that business owners can leverage to plan with confidence. 

Five Tips for Managing Cash Flow

Every SMB would love to maintain a positive cash flow. But it’s easier said than done. Not to fear! Here are some cash flow management best practices that will help your SMB thrive.

1. Monitor Cash Flow Regularly

Just as we keep tabs on our household budgets, conducting regular cash flow analyses is prudent to understand where your small business stands on finance. Several accounting software options are available to generate reports, reconcile accounts, and more.

2. Improve Receivables

Receivables are unpaid customer debts for your business’s products or services. In other words, it’s money owed by your customers to your business. If receivables are improved, you have a predictable income that leads to a positive cash flow.

You can secure prepayment, write waterproof payment policies, incorporate late payment fees, issue invoices promptly, and shorten payment terms for new customers.

3. Manage Payables Wisely

You should ensure that your dues (or payables) for vendors and suppliers are on track as you anticipate your client payments. If you do so, your cash outflow will be accurate. You can employ several methods to manage your payables wisely:

  • Centralize the accounts payable process.
  • Prioritize invoices.
  • Maintain transparent and accurate transaction records.
  • Reduce manual intervention where possible and shift to automation.

As a business owner, you can certainly appreciate the impact this will have: your brand will be seen as responsible, transparent, reliable, and respectful of the livelihood of your business partners. 

4. Maintain a Cash Reserve

If your personal budget has an emergency fund for handling a sudden auto repair expense, there’s no reason why your SMB shouldn’t have its own reserve of cash.

Putting aside a few months’ worth of expenses is a hedge against unexpected business expenses and an investment in new growth strategies. You might hire a new employee, find an investment opportunity, or realize your coffee machine is busted. Or all of the above.

You can deposit a portion of excess cash into FDIC-insured money market deposit accounts that allow immediate access at any time. However, it’s also important to remember that a lot of cash sitting idle is an opportunity cost, which means that when it isn’t being invested, it isn’t earning a return either.

5. Reduce your Expenses

Reviewing your cash flow cycle from purchasing to sales, you might notice some expenses that could be pared or eliminated over the long term. For example, you could use free tools, save on printing supplies by going paperless, or travel less often.

As your small business scales and adopts best practices, this efficiency could translate into positive cash flow. This is because you were previously paying a lot more in the present for expenses incurred in the future.

A great way to start reducing expenses is to create a business budget.

By setting spending limits for different areas of your business, a budget helps prevent overspending and encourages the more strategic allocation of resources. It also allows for the early identification of potential financial shortfalls, offering the opportunity to adjust plans before these issues escalate. 

Impact of Cash Flow on Access to Capital

Congratulations! Your business is working well, everything looks stable and strong, and your cash flow is positive. But to take your business to the next level, you need capital.

If you apply for funding, lenders will look at your cash flow to check if you can repay them. They will scrutinize your bank statements, employee pay stubs, and tax documents. What are they looking for? In most cases, the answers to a few simple questions. 

Can You Pay Back Lenders?

Positive cash flow is evidence that a business generates enough revenue to cover operating expenses and has a surplus to service debt.  Debt service includes repaying principal amounts and paying interest on borrowed capital. 

Having surplus cash flow allows businesses to honor their debt commitments promptly, maintaining good relationships with creditors and preserving their creditworthiness.

An ongoing surplus is a robust and positive indicator of growth and stability to your lenders. Lenders use cash flow analysis to determine the maximum amount they’re willing to lend, ensuring that businesses can handle repayment without jeopardizing their operations.

How Risky Is It To Lend to You?

If your cash flow is positive, it shows lenders that you can weather economic downturns, stay on top of operational costs, and honor your debt commitments. A weak or negative cash flow signals the opposite: that your business is struggling and may be risky to give you access to capital.

Are You Credit-Worthy?

Cash flow charts and other parameters like debt-to-income ratio and historical revenue determine your creditworthiness. Consistent cash inflows signal responsible, mature, well-managed businesses and a lower loan default risk.

Can You Qualify for Better Terms and Interest Rates?

The relationship between a business owner and a lender is a symbiotic one: lenders look for low-risk, reliable partners who pay them back on time, and businesses gravitate to lenders who trust them with capital. With strong cash flow, you are more likely to secure favorable loan terms and lower interest rates.

Having a sustained, positive cash flow is also empowering! You get access to a variety of funding options: traditional bank loans, lines of credit, and even equity financing. Negotiate from a position of strength by choosing the best funding solutions for your needs.

Cash Flow and Alternative Financing

So, in summary, a consistent positive cash flow is one of the hallmarks of a financially responsible small business. Regarding traditional funding, these businesses enjoy larger dollar-value loans, lower interest rates, and favorable loan terms.

But what about alternative financing options like revenue-based financing (i.e., a merchant cash advance)? 

In this model, repayment terms to funders are directly tied to a business’s sales volume. A business will receive upfront capital in exchange for a portion of its future sales revenue (i.e., it’s not a loan). The health and predictability of a business’s cash flow are crucial because they determine the business’s ability to generate consistent sales and, consequently, repay the advance in a timely manner.

Funders in revenue-based financing models assess cash flow to gauge the business’s ongoing revenue generation capacity, ensuring that the advance can be repaid through the agreed-upon percentage of sales without straining the business’s financial health.

In short, a positive cash flow will act as your buffer to make daily or weekly payments, determine a flat rate set in advance, or set dynamic rates that change depending on sales.

Nexi: Your Partner in SMB Success

With this article, we’ve thoroughly made our case for the importance of a positive cash flow for SMBs. It’s one of the true measures of success.

But healthy cash flow can only get you so far. 

You need capital to get your business to the next level of growth. While traditional loans have their place, they come with lengthy application wait periods, tedious paperwork, and requirements for collateral that are often beyond the reach of small businesses. 

Nexi has been an ally for SMBs since day one. We are a leader in responsible alternative financing and offer lump sums of up to $500,000 with a term period of 18 months. Get approved and access to funds within 24 hours.

To learn more, contact a Nexi representative to discuss your unique needs, or apply here.

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