Starting and owning a small business can be one of the most fulfilling things you can do in life. It brings with it the feeling of self-actualization and the liberties that come with being your own boss. However, as is always the case, to enjoy the freedom of being your own boss, you also have to carry more responsibilities with you to make ends meet. With suppliers sending in their invoices, end month drawing near with employees to pay and rent owed to the landlord; you cannot afford not to manage your cash flows well as a small business. Otherwise, you will find yourself out of business very fast due to liquidity challenges.
To avoid being cash trapped and end up closing shop, you need to explore all the options available to your small business to keep it afloat as you develop stronger financial muscles over time; to help you remain resilient in tough economic times. Among the options available to you as a small business include prepayments from customers, cash cycle management, short-term loans with low rates and inventory management.
Prepayments From Customers
Getting your customers to pay for your goods or services before you actually deliver them can be a very positive boost to your cash flows for your small business. The prepayments help you to have cash in hand to acquire any inputs required by your business to produce the required amounts of goods or services. This will then ensure that you meet your customer demands on time since you always have their products ready way in advance since you can acquire inputs from the suppliers at the right time. However, payments in advance should be treated as a debt from the customer, and their use should be judiciously decided to avoid instances whereby you fall short of delivering goods or services already paid for.
Cash Cycle Management
In most businesses, you will always find yourself buying on credit and selling on credit too to your customers to keep the business running at all times. Buying in credit is a positive thing for your small business cash flows since you do not have huge cash outflow before you can start earning income from your customers. Often suppliers will give you about 30 days of credit period within which you are supposed to pay them for the inputs supplied. This gives you time to produce your goods or services, sell them to your customers then get cash to pay the supplier.
However, the above cycle is not always as smooth as it sounds. To keep your customers within your fold too, you will need to sell to some of them on credit too. This distorts the seamless flow of processes as described above since your receivables might take longer to be settled by your customers; hence going beyond your 30 days credit period given by your suppliers. Under such circumstances, liquidity issues start cropping up in your business, and you might end up being financially distressed.
To avoid such eventualities, you need to align your credit period with suppliers and credit period you give to your customers in such a way that you always have cash to pay your suppliers as and when the payables are due. [pullquote] You achieve this balance by ensuring that you negotiate for long payable days with your suppliers and shorter receivable days with your customers.[/pullquote] For instance, if your payable days are 45 and your receivable days are 30, then you have a 15 days window to pay your suppliers and ensure that your small business runs smoothly. The rule of thumb is always to ensure that your payable days are longer than your receivable days; then have a strong debt follow-up mechanism to ensure customers pay on time.
Closely related to cash cycle management is managing your inventory such that you keep your inventory costs low. This is majorly applicable to small businesses that sell commodities as compared to those who sell services. To keep your inventory costs low, you need to apply the just-in-time model where you only acquire new inputs when there is demand for outputs. By streamlining your operations in this manner, you can avoid accumulation of inventory at your business premises at a cost. You also have higher liquidity since your cash is not tied up in idle inventory.
As a normal business practice, you should only borrow when your business activities are not able to generate enough cash flows to pay for all the business expenses. In the instance you end up taking a loan, it should be matched with the business needs at that time. If you have short-term financial needs, then you borrow a short-term loan to meet those needs. Also, you should always ensure that the returns you will get after investing the borrowed funds exceed the cost of the loan; hence laying a case for the low-interest loans as being preferable for small business owners.
In summary, loans should, however, be used as bridges to help you cross over from a situation of financial distress to getting your small business up and running and generating enough cash flows to pay all the business expenses. In the day to day running of the business, negotiating for longer payable days and shorter receivable days will go a long way in helping you maintain a sober balance in your cash book.