Small Business Cash Flow Management Made Simple

Why Is Cash Flow Management So Important for Your Small Business?

Did you know that poor cash flow management is one of the reasons small businesses fail? Without strong cash flow management, your business can end up in a challenging position—struggling to meet its obligations, maintain fruitful relationships, keep happy customers and uphold the reputation you’ve worked so hard to shape.

With good cash flow management, your business can do all of these things and more—it’s the main ingredient to long-term, sustainable success. Let’s take a look at what healthy cash flow can do for your business.

Cover Operating Expenses Through Highs and Lows

Your operating expenses—like rent, employee salaries, marketing, insurance, equipment, raw materials, research and development and inventory—are typically constant, meaning they don’t pause when your client is late paying an invoice or your business is navigating a slow season.

Picture this: You need to buy inventory to launch your new winter line before the busiest shopping season of the year. Eventually, you’ll sell that inventory and see the profit, but it might take a few months. This is an example of a cash flow gap—something that can make or break a company depending on its cash flow management strategies.

If your cash flow hasn’t been managed properly, you might not be able to pay your employees on time after you purchase all this new inventory. But if you have effectively managed your cash flow then you have cash reserves to fall back on until the money from this launch comes in.

Build Resilience to the Unexpected

On a similar note, good cash flow management—through things like monitoring, forecasting and controlling your cash flow—can help you build reserves like an emergency fund.

While it can be easier to predict slow seasons and other historical ebbs and flows, unexpected curveballs like repairs, replacements, unplanned maintenance, employee turnover or even a pandemic can seemingly appear out of nowhere. It’s crucial to expect the unexpected and create a cushion for when it arrives. (We’ll dive into more strategies to do exactly that later in this article.)

Empower Strong Decision Making

When you fully understand the movement of your cash, you can make better decisions about your future. Whether you’re thinking about hiring new staff, revamping your marketing efforts or exploring loan options, cash flow insights and reserves can help you feel more confident and strategic about these big decisions.

Reduce Risk of Debt

By monitoring and forecasting your cash flow, you can reduce your reliance on debt to cover short-term operating expenses. Cash flow forecasting allows you to predict potential shortages and plan ahead—cutting unnecessary costs to prevent these shortages.

Improve Partner Relationships

In general, healthy cash flow signals to your suppliers, vendors and partners that your business is in good standing and worth trusting.

On a more granular level, cash flow management can help you pay your vendors on time, unlock potential payment discounts and give you stronger grounds for negotiation. At the end of the day, you want to keep your partners happy to reduce any supply chain interruptions—and you want to give your business the best chance of preferable payment terms.

Secure Financing

Healthy cash flow shows lenders that you have a solid track record of repaying your debts (both short and long term). Lenders will take a close look at your cash flow statement, including your operating, investing and financing cash flow history (we’ll cover these types of cash flow in detail below). In particular, financing cash flow (also known as cash flow from financing or CFF) is usually a strong indicator of how well your company can handle new debt. Banks look at it to get a clear understanding of your cash flow—and confidence that you can manage new loan repayments.

Get to Know Different Types of Cash Flow

The overall concept of cash flow is split into three main categories:

• Operating
• Investing
• Financing

Let’s take a closer look at each of these below—and some other common types of cash flow you may need to know.

Operating Cash Flow (OCF)

Operating cash flow comes from your day-to-day products and services. It reflects your company’s ability to generate cash from its main purpose.

If you’re a mechanic, are your operations bringing in more cash than the money you’re putting towards parts? If you own a retail brand, are your sales outpacing the costs of your inventory? These considerations fall under operating cash flow.

Investing Cash Flow (ICF)

Investing cash flow covers the money that goes towards your company’s long-term assets—and the cash generated by them over time. Because these are long-term investments, they reflect future growth. Some examples include equipment, property, a revamped website, lending money to other businesses or acquiring another company.

A negative ICF might mean your company is heavily invested in future growth, while a positive ICF suggests your company may have cut back on investments or recently sold an asset.

Financing Cash Flow (FCF)

Financing cash flow represents the amount of funding your company gains or loses. It covers things like debt repayments, equity transactions, dividend payments, issuing shares and other transactions with investors, lenders, shareholders and creditors. All of these elements shed light on your company’s long-term stability and potential for growth.

Net Cash Flow (NCF)

Net cash flow gives an overall view of your company’s cash movement, encompassing the total amount of money that flowed to and from your business over a specific time period. It considers all business activities, including operating, investing and financing.

Free Cash Flow (Also FCF)

Free cash flow is a narrower view of net cash flow, representing the money your company has left over after covering its operational costs and necessities. In other words, it’s the cash you have available for things like investments and growth opportunities.

Discounted Cash Flow (DCF)

Discounted cash flow is a way of estimating the value of a future stream of cash (like an investment) in today’s dollars. For example, say your business expects to earn $200,000 in the next fiscal year. The DCF model helps you determine what that future $200,000 is worth today, factoring in things like risks, inflation and the potential for your money to earn interest through investments.

DCF helps you compare the cost of an investment today with its potential future returns, so you and your investors can make more informed decisions.

Other Important Terms to Know Related to Cash Flow Management

Here are some other helpful terms to know when discussing and practising cash flow management.

Cash Inflows

Cash inflows are exactly what they sound like—sources of cash flowing into your business and increasing your amount of readily available money. Some examples include sales, royalties, tax refunds, investment returns and money raised by issuing stocks and bonds.

Note: Accounts receivable (money owed to your company for goods or services it provided) are considered cash inflows.

Cash Outflows

Cash outflows represent the money flowing out of your business for things like day-to-day operations, debt payments, emergencies and more. It’s crucial to understand and manage your cash outflows to promote the financial health and stability of your business.

Note: Accounts payable (short-term debts you owe to vendors and creditors) are considered cash outflows.

Profit

Profit is your net income, or the money left over after you pay all your business expenses (unlike cash flow, which encompasses all the money flowing to and from your business).

Cash Flow

Money flowing to and from your business

Profit

Your net income after paying business expenses

Your business can be highly profitable yet still encounter cash flow issues. For example, if the timing of your money inflows and outflows doesn’t match up, you can experience cash flow gaps.

Note: It’s important to consider non-cash expenses like depreciation, which can reduce your profit over time without immediately impacting your cash flow.

Cash Flow Statement

Your cash flow statement summarizes all the cash moving in and out of your business during a specific time—like a month, quarter or year. When paired with your income statement and balance sheet, your cash flow statement plays a key role in reflecting your company’s overall financial health.

Cash Flow Forecast

A cash flow forecast estimates your company’s future cash inflows and outflows over a certain timeframe, such as:

• 30 days (short-term)
• 2-12 months (medium-term)
• 1-5+ years (long-term)

Your cash flow forecast displays your projected cash “position” based on your inflows and outflows, which will play an important role as you (and any investors you have) make decisions around funding, expenditure and investments.

Cash flow forecasting is central to the overall financial health and longevity of your business, so we’ll be discussing it more later.

Cash Flow Analysis

While a cash flow forecast is forward-looking, a cash flow analysis is backward-looking. It’s the process of looking back on a cash flow statement to gauge your company’s liquidity, financial health and overall ability to meet its financial obligations.

A cash flow analysis can guide your financial planning, risk management, growth strategy, operational spending and overall cash management approach.

Days Inventory Outstanding (DIO)

DIO refers to the average amount of time it takes to sell your inventory. This is important because it represents how quickly your business can turn inventory into cash.

Note: DIO is also known as Days Sales of Inventory (DSI).

Days Sales Outstanding (DSO)

DSO refers to the average amount of time between a sale and when your business collects payment. In other words, it’s the time it takes to turn accounts receivables into money in your business bank account.

Days Payable Outstanding (DPO)

DPO represents the average number of days it takes for your company to pay outstanding vendor invoices. It reflects how well your company can increase its cash flow by extending the amount of time before payment (while staying within the payment terms). In other words, it’s the time it takes to turn accounts payable into an outgoing payment.

For a more detailed definition and formula, check out Your Go-to Guide on the Accounts Payable Process.

Burn Rate

Simply put, burn rate measures how fast or slow your company spends its cash. It signals how long your company can run before it depletes its cash reserves and needs additional funding. A low burn rate can signal financial stability, while a high burn rate can signal the opposite. Occasionally, a high burn rate can also indicate rapid growth and effective use of resources—but only when it’s paired with steep revenue gains.

Working Capital

Working capital is the money your company has available to cover your short-term expenses and debts. It’s the difference between your current assets and current liabilities, giving you a snapshot of your company’s ability to carry out its daily operations.

Note: Although cash flow and working capital are distinct, they have a direct impact on each other. Say a customer or partner owes you money, which raises your accounts receivable. This can increase your working capital, but it doesn’t mean your business has more money to spend right now.

Cash Conversion Cycle (CCC)

The cash conversion cycle measures how efficiently your company converts investments (for example, the money you spend on inventory) into cash flow from sales.

As a reminder:

• Days Sales Outstanding (DSO) is the average time between sale and payment collection
• Days Inventory Outstanding (DIO) is the average time it takes you to sell your inventory
• Days Payable Outstanding (DPO) is the average time it takes you to pay outstanding invoices

How Does Accounts Payable Affect Cash Flow—and Vice Versa?

First things first, accounts payable are the outstanding short-term debts your business owes to a vendor or supplier. When your accounts payable balance increases, it means you’ve purchased a good or service on credit, and you’ll “settle up” at a later date. By creating a gap between the purchase and the payment, you’re delaying a cash outflow for your company. This allows you to hold onto more cash, having a positive impact on your cash flow.

Your cash flow also impacts your accounts payable process. Healthy, predictable cash flow helps your company pay its vendors and suppliers on time (or early), which can improve relationships, unlock payment discounts and even lead to better credit terms in the future. Poor cash flow can have the opposite effect on your accounts payable process.

Common Mistakes in Cash Flow Management

We mentioned that poor cash flow is one of the reasons that small businesses fail. Let’s talk about a few common mistakes, so you can avoid them and set your business up for success.

Avoiding Cash Flow Forecasting—or Forecasting Incorrectly

Skipping over cash flow forecasting—or doing it wrong—can put your business at serious risk. Be sure to avoid common mistakes like ignoring unexpected expenses, seasonality, delayed payments, external factors (market trends, inflation, etc.) and more. We’ll dive deeper into forecasting best practices in the next section.

Mistaking Profit for Cash Flow

Remember, profitability doesn’t equal healthy cash flow. Equating those two can lead to some big issues, including operational disruptions, late payments, strained vendor and supplier relationships, high dependence on credit, reputational damage and more. For example, a company may not collect money from a customer until several months after a sale; however, all of their expenses still need to be covered, which can lead to cash flow strains.

Overspending During Good Times or Growing Too Fast

It can be tempting to overspend during good, profitable times—buying too much inventory, splurging on higher-quality goods, revamping your marketing efforts or hiring new employees.

While it feels natural to grow and improve when your business is profitable, it can deplete your cash reserves for slower seasons and lead to a lot of the same issues we’ve mentioned throughout this article.

Keeping Too Much Inventory

Overstocking your inventory can tie up your cash, creating a roadblock in your cash flow. It can also increase your storage costs and put your goods at risk of deprecation.

Poorly Managing Accounts Payable and Accounts Receivable

Are you managing your payables and receivables processes manually? If so, this can cause several challenges that trickle into every aspect of your operations and negatively impact your cash flow. Whether you’re dealing with mismatched invoices, late payments, insufficient funds, workflow bottlenecks, weak visibility/reporting or something along those lines—it could be time to streamline your accounts payable and accounts receivable processes (or at the very least, tighten them up).

Not Knowing When to Ask for Help

Keep an eye out for these signs that it may be time for your business to ask for help with cash flow management.

• Consistently cutting it close on payroll and bills
• Relying on loans and credit cards for daily costs
• Not having visibility into where money is going
• Inconsistently forecasting cash flow (weekly, monthly, quarterly or annually)
• Making decisions without fully considering the cash impact
• Not understanding your cash flow statement

Do any of these signs ring true? If so, it might be time to review resources on cash flow forecasting and management or reach out to a trusted advisor like your accountant, bookkeeper or mentor.

Powerful Cash Flow Management Strategies

Now that we’ve covered common mistakes, let’s dive into some powerful strategies that can help your small business strengthen and sustain its cash flow.

Cash Flow Forecasting, the Right Way

Whether you’re creating your first cash flow forecast or finetuning your approach, here are just a few best practices to keep in mind.

• Use historical financial data. You want to use real data when establishing your forecast baselines and projections for inflows, outflows, revenue, variability and more.
• Account for external factors. Things like inflation, market trends, interest rates and political changes can impact your cash flow.
• Automate data collection. Wherever possible, digitize your data to ensure relevance and accuracy. Some examples include accounting software, payment solutions and enterprise resource planning (ERP) systems.
• Track all operating expenses. Categorize each expense into a specific bucket and review new contracts to account for upcoming expenses too.
• Monitor and adjust regularly. Cash flow forecasting is not a one-and-done process. It’s ongoing, and it requires constant adjustments as your business evolves.
• Maintain short-, medium- and long-term forecasts. Most businesses forecast monthly, quarterly and annually. If your business is rapidly changing, consider weekly forecasts too.

If you don’t have historical data, try to estimate demand and do competitor research. See if there are any statistics on average sales for your industry and try to estimate what similar businesses might generate and spend.

If all else fails, consider what you must sell to cover your costs and use that as a target.

Improving Payments Through Automation

You can streamline and automate your payments process with RBC PayEdge whether you’re an existing RBC business customer or not. RBC PayEdge can save time and smooth out cash flow gaps by allowing you to combine funds from multiple accounts and pay via credit card—even if the recipient doesn’t accept cards. This way, you don’t have to wait for funds to become available in a specific account, which could lead to late payments and other cash flow disruptions. Check out even more benefits here, including automated approvals and payment reconciliation.

You can also get paid faster with efficient incoming payment solutions, including:

• Interac e-Transfer^‡, which makes it easier to streamline your payments¹
• Moneris^‡, which allows you to accept payments in-store, online or on the go and receive funds in your RBC business bank account the next day
• Cheque-Pro^®, which lets you deposit up to 250 items to your Canadian and U.S. dollar business accounts and receive same-day credit for deposits made before 10pm ET

Maintaining Cash Reserves

It’s worth repeating that your business needs to maintain a cash reserve (aka an emergency fund) to prepare for the unexpected, maintain liquidity, make informed decisions, seize growth opportunities and more. Here are a few tips to help you grow your cash reserves.

• Open a reserves account. Consider keeping your reserves in a separate business savings account, so you’re not tempted to use them. Choose from account options that range from regular savings with tiered interest rates to investment savings to earn more interest as your balance grows.
• Determine a comfortable amount. Similar to a personal emergency fund, you should aim to save at least 3-6 months of business expenses.
• Set up automatic transfers. This way, you won’t forget to manually transfer the money or be tempted to procrastinate.

If you don’t feel like you have the money to put toward an emergency fund, it may be time to explore new ways to increase your sales or trim your expenses.

Controlling Inventory and Reducing Wasted Resources

Below are some tips to get you started on trimming your expenses.

• Audit your outflows
• Set a new budget
• Streamline manual processes with automation
• Review and compare insurance policies
• Shop around for vendors and suppliers
• Leverage data to more accurately estimate demands
• Use inventory management software to track and reduce

By cutting down on unnecessary resources, you can improve your cash flow and free up funds to put toward your reserves or pursue more growth opportunities.

Considering Strategic Financing Options

If you’re still experiencing cash flow issues after implementing these strategies, it could be time to consider new financing options. For example, you may be able to use a business line of credit or business credit card to finance your operations, everyday cash flow or equipment.

When considering new financing options, it’s important to compare all the terms and even consult with a financial advisor to make sure your decision aligns with the long-term goals you’ve set for your business.

To Summarize: Cash Flow Management Dos and Don’ts

Cash Flow Management Dos	Cash Flow Management Don’ts
Forecast regularly	No forecasting
Use payment automation	Manage payments manually
Maintain cash reserves	Overspend during good times
Control your inventory	Keep too much inventory
Consider strategic financing options	Not asking for outside help