3 Rules About Cash Flow That First-Time Business Owners Need to Know
Many first-time business owners think about cash flow only when their cash reserves are low. Small business owners, however, know that, for them, “cash is king.”
For many businesses, getting paid isn’t the problem – it’s when. Lumpy cash flow is a stressful experience for business owners because the consequences can include delayed paychecks to employees, missed bill payments or stalled growth due to an inability to take on new clients. So, how can business owners avoid putting themselves at the mercy of clients and when those clients mail their checks?
Shegar Thirumalai, a serial entrepreneur and owner of a San Diego-based security company, had an answer. He sought working capital financing even before he had a need. When asked why, he pointed to his previous experience and said, “Even if I don’t need it now, I will always have a reserve. It’s worth it, even if you have to pay a little interest.”
As a result, said Thirumalai, he was recently able to land a large client who wanted his services -- starting the next day. Thirumalai used his credit line to front the $20,000 in payroll before cash started coming in from the client.
Here are three tips on how to think about cash flow based on the experience of successful entrepreneurs like Thirumalai:
1. It pays to be proactive.
A business owner’s time is his or her most valuable resource, and is better spent growing and managing the business than fixing a cash-flow crisis. Clearly, it's hard to spend time on important business operations when you are constantly matching outgoing payments with incoming checks.
Having sufficient working capital in place to take care of lumpy cash flow -- whether it's for a cash reserve or funding source -- gives you breathing room so you can focus on your priorities and sleep better at night.
Whether your business has one employee or a thousand, spending your time on the front lines of your company instead of in the back office doing administrative tasks is almost always better for your business. In Thirumalai's case, having a source of funding in place led to tremendous growth rather than having to turn down a major new account.
Being prepared also allows you to negotiate from a position of strength. Shopping during a crisis makes you easy prey for shady financiers. Many short-term lenders offer confusing terms or long-term contracts with hidden fees to lure in clients who don’t have time to do their research.
These hidden fees dramatically increase the actual cost of getting financing. Plus, the long-term contracts mean that your need for short-term cash turns into a long-term drag on your company if you have to meet financing minimums. So, don’t go grocery shopping while hungry, and don’t look for a cash flow solution when you’re most vulnerable.
2. Consider the ROI of financing, not costs alone.
Financing is almost always a better alternative than delaying payroll or turning down business. A new business owner focuses on the cost of financing; an experienced owner knows that the hit to morale from delaying payroll or the lost profit from passing on a new client are both more costly than the short-term cost of financing.
For Thirumalai, securing funding before he needed it allowed him to grow his business. He considers winning the client he did to be the proudest moment for his business in the last six months, and that wouldn’t have been possible without his credit line.
3. Know your options.
Experienced business owners like Thirumalai know that a single quarter of bad cash flow can spell disaster for a small business. So their solution is to find financing options before a crisis hits. While understanding your options is the first step, a recent survey conducted by my company, BlueVine, revealed that 40 percent of small business owners said they couldn’t explain any of the small-business financing options available to them.
Here are three options for managing your cash flow and growing your business:
- Offer a vendor discount. For example, offer clients a discount for paying invoices before the due date. Giving a 2 percent discount for invoices paid within 10 days is common practice and will incentivize some customers to give you cash faster. A disadvantage is that you still won't be fully in control of your cash flow -- your customers will be.
- Get a business line of credit. A business line of credit lets you draw funds as needed, so you always have a ready source of cash to tap into when there is an expansion opportunity or a dip in cash flow.
- Use invoice factoring. Invoice factoring companies offer financing tied to business invoices. The result is a credit line, like a business line of credit, except that because it is tied to specific invoices, you usually get better rates.
The takeaway: Plan ahead.
Thirumalai’s experience taught him that a cash-flow crunch is disruptive for a business. The best time to think about cash flow, then, is before you have a need.
By securing a ready source of working capital ahead of his need, Thirumalai grew his business while avoiding the cash-flow crunch that hurts many businesses. Be proactive, consider the return, research your options and negotiate from a place of strength so you can avoid a common source of grief for many first-time business owners.