One of the most important things you can do for the financial health of your small business is to monitor your cash flow - the amount of money going in and out of the business. Sounds simple, right? But many small business owners find themselves with unexpected shortfalls, or don’t prepare for slower months.
If you run out of available cash, you run the risk of not being able to meet your current obligations such as your payroll, accounts payable and loan payments.
We spoke to Kevin Cochran, co-founder of the wealth building and financial literary training series Enriched Academy, to learn more about the cash flow mistakes to avoid as a small business owner.
1. Neglecting to monitor your cash flow
“Make sure you know every dollar going in and every dollar going out,” Cochran says. “You'd be surprised how many people don't do that.”
Take the time to monitor your cash flow on a daily or weekly basis. This will shine a light on where you’re getting the best return on your dollar.
“If you really break it down, you'll realize a large portion of your business is coming from a very small portion of your clients,” Cochran says.
If you find a specific product is performing well, it could be an opportunity to streamline your portfolio or adjust your pricing.
Consistently reviewing your cash flow will also help you catch overdue payments from clients, see if your own bills are overdue and determine if a slow month is cause for concern or just a cyclical part of your business.
Cochran talks to many small business owners who have a problem with spending too much money in the beginning.
He urges business owners to keep overhead as small as possible. Look at every area of the business that costs money, from coffee to staff to office space.
Do you really need to lease a new car? Can you cut back on rent? Are there loans you can renegotiate? Can you switch to a bank with a lower monthly fee?
He says if you’re overspending in one area, there’s a good chance you’re overspending in other areas.
“The challenge with too many businesses is they get spaces that are way too big,” Cochran says. “They say, ‘Oh, we’ll grow into it.' Or people get a car that’s way beyond their budget. They commit themselves to things they can’t get out of, like long-term leases on these huge properties they don’t need yet.”
3. Not maintaining cash reserves
It’s a good idea to maintain several months of cash reserves for those times when your business hits a bump in the road.
Set up an emergency fund so you can cover your personal expenses when you’re not bringing home income.
It’s very unlikely you’ll see a profit right away, and you might run into an unexpected shortfall that requires you to tap into your savings.
It’s up to you how much of a cash reserve to build up, but make sure that you’re prepared for slower months.
“If you're running a small business, inevitably you're going to have that month,” Cochran says. “At some point in your business, you're going to run into a hiccup. And it usually starts about six to eight months after you open your business because you think, ‘Oh, I'll have six months in the bank to pay my bills and by then at least something will be happening.' And then you realize, like most small business owners, not much is happening. And that's where the novelty of running your own business is gone and now you're a little stressed out.”
Balance a cash reserve with investing, since you don’t want to be sitting on a large amount of money without a return.
4. Missing out on investing
Once your business is profitable and you’ve got a good handle on the finances, Cochran recommends investing the property or business into different assets to generate passive income. He says you should pick one or two ways to invest, whether it’s investing in other businesses, real estate, the stock market or private mortgages.
Here are some basic tips for investing.
1. Start investing as soon as possible. You don’t need a large amount of capital to start investing. For example, if you decided to invest in mutual funds, even if you start with a very small amount of money, you’re going to see benefits from compound returns (re-investment of earnings over time).
2. Diversify - You could invest in other businesses, real estate, the stock market or private mortgages. By investing in a variety of industries and sectors, you’re reducing your overall risk. If some of your investments are performing poorly, you could still see a return from investments in other industries and sectors.
3. Take advantage of Registered Savings Accounts - Investment income is tax-free in a registered retirement savings plan (RRSP) until you withdraw the money. Contributions to the RRSP are tax deductible so you receive immediate tax relief and tax-sheltered growth. The tax-free savings account (TFSA) lets you contribute $6,000 a year and you don’t pay tax on investment income or withdrawals.
5. Not hiring a tax specialist
Cochran says once you get to a point where business is profitable, you’ll want to hire someone to handle your finances.
“Make sure you find the right person that can help manage your money properly because there's no point to make all this money, only to have it not being managed in the back end,” Cochran says.
A tax specialist will keep your books and records in order, track your progress and compare past and present financial positions, plan and forecast future financial positions and provide information to make sound business decisions. Plus, they’ll keep on top of filing tax returns so you avoid penalties and interest, and reporting obligations to the Canada Revenue Agency to save you time and energy if your small business gets audited.
What tools can help me with cash flow?
FBC has a free calculator that can help you get a quick picture of your current cash flow. We've also listed 10 areas you should be focusing on to see where you're spending too much money, and where it might make sense to increase your spending.
FBC is a third-generation family company that works with Canadian small business owners to minimize their income taxes and maximize their assets. Contact us today to find out how we help your business year-round with tax planning, preparation and consulting through our unique, industry leading Membership model.