By following our 10 cash flow management tips for small business operations—including not paying bills until due, utilizing a credit line, investing excess cash, establishing a petty cash fund, and determining your cash conversion cycle—you can meet short- and long-term cash requirements and optimize return on idle funds. Cash flow management is important for all businesses, regardless of size and nature. Knowing the timing of all cash inflows and outflows can help you maximize your spending and maintain a healthy amount of available cash for emergencies or unforeseen circumstances.
1. Don’t Pay Bills Until Due
Maximize your available cash by postponing bill payments until their actual due dates. This strategy frees up cash flow, which can be temporarily allocated to cover payroll or taxes. As long as there’s no early payment discount offered by the vendor, holding off on payments can be the most effective way to optimize your cash reserves.
However, the caveat is that delaying payments might cause you to overlook them, potentially leading to late fees or damage to your creditworthiness with vendors. We recommend using one of the best accounts payable software to help track your bills.
2. Invoice Customers Quickly Once Work Is Complete
A common problem in small business cash management is a delay in invoicing once a job is done. An invoice is a request for payment asking the customer to pay the amount within a relatively short time period, such as 14 or 30 days. Ideally, you should have the invoice ready within 48 hours after the work is completed. However, it’s even better if you send an invoice right away.
Our related resources on invoicing:
- Invoice designs: Invoice Examples: What to Include + Best Practices
- Payment terms: Common Invoice Payment Terms and Tips on Setting Them
- Free invoice tracking: How to Track Invoices Using Excel [+ Free Template]
- Invoice numbering: What Is an Invoice Number & How to Design a Numbering System?
3. Reconcile Bank Accounts Regularly
You must perform bank reconciliations once a month to ensure that both your cash ledger and bank account are accurate and complete. As soon as you receive monthly bank statements, you—or someone not authorized to sign checks or make deposits—should start reconciling the accounts to 1) determine the status of outstanding checks and deposits; and 2) update the books for bank debits and credits. Withdrawals not recorded in your books can easily lead to overdrafts and costly penalties.
Our roundup of the best bank reconciliation software provides you with top five recommendations for performing bank reconciliations. If you’re new to this, we have a guide on how to do a bank reconciliation.
4. Utilize a Line of Credit
A business line of credit is a borrowing limit that you can borrow from at any time. It gives your business more flexibility in managing cash payments, as you can use it to smooth out uneven cash flow fluctuations—such as unexpected delayed payments from customers or emergencies. Getting cash from this might make sense to take advantage of vendor payment discounts and avoid late charges.
In our expert opinion, you should use a credit line strategically, not just a quick fix to your cash flow problems. Also, use it wisely because banks and credit unions charge interest.
5. Accept Electronic Payments or Checks
Asking customers to use electronic fund transfers (EFTs) and checks is one way of reducing the presence of cash on your business premises. The more cash you keep on the business premises, the higher the risk of theft or loss.
Electronic payments, such as credit card and EFT payment, and checks are safer to use compared with cash payments because they reduce theft risk and speed up payments at the same time. Even if credit cards charge processing fees, it’s a small amount to pay for security and convenience.
If your small business still doesn’t accept credit card payments, you’re losing on a lot of customers. Statistics show that a credit card is the leading payment method in the US. Learn how to accept credit card payments online for free.
6. Deposit All Cash Regularly
To reduce the risk of theft or loss, deposit collections in the bank regularly. It doesn’t need to be daily if you think that would be too demanding. As much as possible, deposit cash at least once a week so you don’t hold too much cash physically. It’s better to deposit cash on Tuesdays or Wednesdays since you’ll likely see it show up in your mobile banking account before the weekend. This way, you can access your money sooner and avoid any delays.
A deposit creates a paper trail of what was collected and helps match bank receipts with book receipts. Cash in your bank account is still considered cash on hand for financial statements. Note that it’s best to avoid using daily cash collections to pay for expenses prior to depositing. Instead, establish a petty cash fund as discussed below.
7. Invest Excess Cash
Holding too much cash either on hand or in a checking account isn’t good for your business. While it keeps your business liquid, you’re losing opportunities to earn passive income from idle cash.
A great way to use idle cash is to invest in a money market account, which is designed to maintain a constant market value of $1 per share and pay higher interest rates than typical bank accounts. While it’s very rare for a money market account to lose value, it isn’t insured federally, so beware of the risks.
You can also opt to deposit cash in high-yield savings or checking accounts, which is one of the best ways to earn interest for your business. Even if your money is sleeping in the bank, it’s earning higher interest than traditional savings or checking accounts.
8. Establish a Petty Cash Fund
A petty cash fund provides easy and fast access to cash to pay for incidental expenses. If an expense is too small to write a check for, paying for it from petty cash is more convenient than writing a check.
Our related resources:
9. Segregate Cash Handling and Cash Recording Duties
One of the key principles of good internal control is the segregation of incompatible duties over cash. In cash controls, the person holding the cash or signing the checks, such as a cashier or treasurer, must not be the same person recording cash receipts and disbursements, such as a bookkeeper, A/R clerk, or A/P clerk.
However, if it’s impossible to segregate these duties in a small business environment, the owner should take an active role in cash transactions by reviewing, approving, and knowing about all cash-related transactions in the business.
10. Determine Your Cash Conversion Cycle
The cash conversion cycle (CCC) is a working capital metric that shows the average time from the point cash is used to purchase inventory until it’s collected from credit customers. In other words, CCC illustrates the number of days it takes to convert cash invested in inventory back to cash; hence, a lower CCC is generally better, but not always, as discussed below.
The formula is:
Where:
- Average age of inventory (AAI) is the number of days it takes from the point you purchase inventory until you sell it to customers.
Average inventory | ||
AAI = | ________________________ | x 365 days |
Cost of goods sold | ||
- Average age of receivables (AAR) is the number of days it takes for customers to pay once an invoice is issued.
Average A/R | ||
AAR = | ________________________ | x 365 days |
Credit sales | ||
- Days payable outstanding (DPO) is the number of days it takes from the point you purchase inventory until you pay vendors
Average A/P | ||
DPO = | ________________________ | x 365 days |
Credit purchases | ||
The main goal of analyzing the CCC is to reduce the AAI and AAR and stretch the DPO. Ideally, you want a low CCC because it represents a fast conversion of assets to cash. A low CCC is the result of low AAI and AAR and high DPO:
- High CCC may mean that AAI and AAR are high while DPO is low.
- Low CCC may mean that AAI and AAR are low while DPO is high.
Meaning if High | Meaning if Low | |
|---|---|---|
AAI | It may signal declining or slowing sales because inventory is taking longer to sell. | It points to rising sales, as inventory is moving quickly. |
AAR | It suggests you're not collecting from customers regularly, possibly due to an overly lenient credit policy
An overly lenient credit policy means that the business is granting too many credit sales without giving enough consideration to the customer’s creditworthiness. Lenient credit policies can result in high sales but more bad debts, fewer cash collections, and more collection costs.
, which can hurt your cash flow. | It indicates you're collecting from customers promptly, likely by offering early payment discounts or extending credit only to reliable customers. |
DPO | It suggests you're paying vendors as close to the due date as possible. However, it could also mean you might be missing some deadlines, which can harm your creditworthiness. | It suggests you're paying vendors too early unless you're getting an early payment discount. Otherwise, paying ahead of time can strain your cash flow, reducing funds available for working capital. |
Frequently Asked Questions (FAQs)
Cash is necessary for daily operations and working capital. Without enough cash, your business might not have enough resources to fulfill daily needs of goods and services for customers.
There are two main goals in cash management. First, businesses need to collect cash from customers as quickly as possible. Second, businesses need to control cash outflows and settle payables at the best time. These two main goals highlight the importance of optimizing cash inflows and outflows.
Bottom Line
Cash keeps your business liquid because it’s the primary means of paying for goods and services. With proper cash management, you can track the inflow and outflow of cash from different sources and assess if you’re utilizing it according to your needs. For small business owners, your participation in managing cash is vital to keeping all transactions accounted for and protecting the business’s cash from theft and misappropriation.
