Handling Cash Flow and Your Bank Relationship » Succeed As Your Own Boss
Poor cash flow management can put you out of business. This article will discuss various strategies for handling cash flow, including securing bank loans and lines of credit, to start and grow your small business.
Keeping Track of Finances
Want to know the key to handling cash flow? Staying on top of your monthly statements.
By the fifteenth of every month, you should have a current balance sheet, profit and loss statement (P&L), and a cash flow statement. These will tell you what your business did in revenues and expenses for the previous month. Your bookkeeper or accountant should produce these three statements for you each month.
Falling behind in this paperwork is dangerous to the health of your business. You need accurate financial information to make sound business decisions. For example, you must know how much each job or product costs you and your profit margin on that particular job or product. You also need up-to-date financial information to track your cost of goods sold.
Just so you don’t get lost amid all the jargon, here are some basic definitions for you to keep in mind as your business proceeds:
- A cash flow statement is cash receipts minus cash payments from a given period.
- A balance sheet is a statement showing your company’s financial position at the end of an accounting period.
- An income statement is your company’s net income for the accounting period, also called a profit and loss statement or P&L.
- The cost of goods sold (COGS) represents the cost of buying raw materials and producing finished goods.
You should also track your expenses against your budget. All the trouble you went to in drawing up that budget will be wasted if you don’t keep to it. In the fourth quarter of each year, you should prepare a budget and revenue projections for the following year. When preparing the budget, it is essential to review your prior year’s projections versus actual expenses. This information will help you create a more accurate budget and reduce out-of-control costs.
Strategies for Handling Cash Flow
The goal in cash flow management is to hold on to your cash as long as you can. It is vital that you not get a reputation as a business that does not pay its bills. At the same time, it is essential to make sure that only priority bills are paid first. To do this, you must develop a process for processing your accounts payable or business bills.
Set aside a regular day to write checks, such as every other Friday. You should never cut a check because you got a call from a vendor unless it’s an emergency, and they are holding goods or services that your business needs. Always make sure your business always has enough cash to function. Find out how your clients process invoices. I have found that, in general, the larger the customer, the worse the payment procedures. If you do not want any delays in getting paid, experiment with some of these techniques:
- Get a signed purchase order. Never start work without a signed purchase order or a deposit. Service businesses should try to secure a 25-50% deposit upfront.
- Negotiate extended payment terms. You need to communicate with your vendors and suppliers about how you will be able to pay them and not burn through your cash flow. Try to get 45-60-month payment terms.
- Provide discounts to customers for early payment. For example, sometimes accounts payable will reach out and offer faster payment with a 2-4% discount.
- Get paid in advance. If you are on a long-term contract, try to negotiate payments a quarter ahead.
- Require EFT payments. Ask your corporate clients to pay using Electronic Funds Transfer (EFT). Funds are wired directly to your business bank account, which means that your money is available five to ten days faster than a check sent by mail. There’s usually a small fee to accept wire payments, but it’s negligible.
- Make sure you can accept all forms of payment. You must be able to accept wire payments, credit cards, PayPal, checks, and crypto in some cases.
- Don’t start employee benefits until after 90 days. Instead, reduce initial labor costs by starting your staff on a “probationary wage” for three to six months. Then, delay the start of benefits until the end of the probation period.
- Use invoice factoring. If you are stuck for cash, factoring is an option. This involves selling invoices or purchase orders to a company that gives you cash for them before your customer pays you for your goods or services. If you do this, you will give up 10-15% of the amount, depending on the age of the receivable. Only use factoring when facing a significant cash shortfall because it eats your profit margin.
Securing a Line of Credit
Handling cash flow is essential to the success of your small business. One way to accomplish this is to secure a line of credit.
Structured like your personal credit card, a line of credit allows you to tap into money as needed to stay on top of ongoing challenges. In addition, a line of credit is suitable for temporary, short-term needs such as purchasing supplies and inventory and financing receivables.
Here are some general tips for revolving lines of credit:
- Pay off the balance on your line of credit as soon as you can. Most credit lines are revolving, allowing you to reuse the funds as they are repaid. You do not want to build up a significant balance on a line of credit that you cannot repay.
- Also, make several payments on the loan’s principal each year. If you do not, the bank can classify you as an “abuser of your credit line.” If this occurs, your line of credit will be termed out, which means your credit is closed and transferred into a conventional term loan at a penalty interest rate.
Applying for a Revolving Line of Credit
The application and repayment requirements are generally far simpler for revolving lines of credit than for traditional loans. There are three kinds of revolving lines of credit:
- One that is unsecured or only requires a personal guarantee
- One secured with collateral
- One that has an SBA guarantee
To apply for a revolving line of credit, you’ll typically need to provide two years of financial and operational information about your business and your personal credit history.
It is best to shop around for multiple options, line up your qualifications in advance, and consider all the costs. Procedures to qualify for, use, and repay a revolving line of credit vary among banks. Nearly all banks charge start-up, transaction, and annual use fees. Some also require yearly reviews of how you’re using your credit line, and, at will, your bank can transition your line of credit into a term loan with automatic monthly payments.
A revolving line of credit offers the convenience of credit cards and many of the same risks. However, unlike loans, interest rates on a revolving line of credit may vary with the market, your payment history, and your balance owed. Therefore, you must manage these funds wisely to make sure you do not abuse them.
Conventional Bank Loans
A conventional business loan may be more appropriate for more extensive, long-term investments such as new facilities, equipment, and other fixed assets.
When it comes to finding a bank loan or a line of credit, the most important thing is your credit.
In the early stages of your business, your personal credit history will influence the bank’s decision to lend you money more than anything else. Banks are continually reviewing lending practices and trying to minimize their risks. Particularly in periods of economic uncertainty, this scrutiny is even deeper for a loan to a small business.
Applying for a Conventional Bank Loan
Know your credit history before going into a financial institution for a conventional loan. Make sure your credit information is accurate and up to date. If you can explain a late payment and know why it is on your credit file, offer your bank a reasonable explanation. It could make a big difference in getting approval. The first step to getting the cash you need for your small business is to have a clean credit report.
There are other questions the bank or other financial institutions will ask you:
- Is your business sound? Have your business plan ready to show that your business is booming and will continue to succeed.
- Do you know how much money you need? Be specific about how much money you need, why you need it, and how you plan to use the funds.
- How will you repay the loan? Outline your plan for repaying the money.
- What guarantors can you offer as security? Specify what you are providing as collateral.
Getting bank loans and handling cash flow can be challenging, but you can do it! If you need assistance, contact your accountant to help you. Do your research to determine which banks in your area make the most small business loans. Ask other business owners about their banking relationships and lending institutions to see if they will introduce you to their bankers. In many cases, it is about who you know and who knows you. The best advice I can share is to borrow money in advance and line up your lines of credit before you need it.
Do you have experience handling cash flow in your business? If you have tips for handling cash flow and securing loans or lines of credit, share them with our community below.