Budgeting and Cash Flow Management for Small Businesses

This article has been contributed by Mr. Ratish Pandey, Business Coach, Executive Coach, and Founder, Ethique Advisory.

Imagine a small boat navigating a vast and unpredictable ocean. Without a clear plan and sense of direction, the boat in a choppy ocean would be tossed and turned by the waves, putting its passengers and journey at risk.

In many ways, small businesses navigate turbulent waters when it comes to their financial journey, as they must steer the complex and dynamic marketplace while ensuring their business's stability and growth.

Over two-thirds of small businesses have admitted to encountering financial challenges, with 43% citing the management of operational expenses as the biggest challenge.

According to a study, budgeting and cash flow management are significant pain points for most small businesses, since 86% state that they would need additional funds if revenues were lost for as little as two months.

Mastering the process of Budgeting and Cash Flow Management can help entrepreneurs and small business owners go a long way in achieving their desired business outcomes.

Below, we'll discuss the best strategies you can incorporate into your business to be successful.

Budgeting for Small Businesses
Understanding Cash Flow Management
Improving a Business's Cash Flow

Budgeting for Small Businesses

The first part of managing a small business's finances is developing a budget. There are several steps for business owners to track and monitor their budget and, subsequently, the health of their companies, and those are:

• Gather Insights: The first step to creating the budget. It involves gathering data relating to the financial and operating metrics of the company. It includes collecting the income statement, balance sheet, and statement of cash flows from the historical financial records, looking at historical sales projections, and understanding the industry benchmarks. Entrepreneurs can then gauge essential metrics, such as customer acquisition costs, inventory turnover, and the lifetime value of a customer. This data is necessary for creating future revenue projections and making informed decisions on undertaking new projects.  
• Segregate Costs: Small Business Owners need to separate the fixed and variable costs in a business to understand the firm's financial flexibility. Fixed or Overhead costs remain constant, such as rent and employee salaries, while variable costs fluctuate based on the business activity, such as material costs and marketing expenses. Small businesses need to minimize fixed costs to a minimum and remain financially flexible in case of adverse economic uncertainty or a fall in demand.
• Zero-Budgeting: Some firms consider this approach extreme, but it can work wonders. The Zero-based approach starts with a clean slate, allocating every rupee based on a company's current priority, ensuring that the resources are being used effectively. The Entrepreneur challenges all historical data and creates a budget based on the current future projections for sales & fixed and variable expenses. Zero-based budgeting approach helps draft a realistic budget for the present.

Understanding Cash Flow Management

While budgeting ensures that the organization's financial health remains healthy over the long run, cash flow management techniques help a company understand its short-term needs. Tracking the cash inflows and outflows helps maintain enough liquidity for the organization to meet its short-term obligations like salaries, rent, and interest payments. Furthermore, cash flow management practices in an organization enable businesses to develop accurate budgets and financial projects while increasing financial flexibility.

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Improving a Business's Cash Flow

There are a few ways for businesses to improve their cash flow:

1. Maintain Cash Reserves – A study by JPMorgan revealed that the median small business holds a cash reserve buffer of just 27 days, forcing hurried borrowing or shutters down in case of an unexpected contingency. Instead, companies need cash reserves for at least six to nine months to weather unexpected challenges, a slowdown in operations, etc.
2. Manage High-Interest Debt and Duration - High-Interest debt is the most sizeable cash flow risk for small businesses. It is reported that only 48% of small businesses meet their financing needs, while 29% fail on account of running out of money. One needs to consider increasing the borrowing duration while opting for the lowest interest rates, which should free up the company's cash flows.
3. Improve Collection Efficiency - Small businesses are often challenged with tracking, invoicing, and collecting payments from their clients, making cash flow management difficult. According to a study by TSI small companies, on average write off 1.5% of their total receivables as bad debts. 93% of companies battle late customer payments. Thus, it is vital for small businesses to focus on improving their collections' efficiency by sending invoices timely and aggressively following up on late payments.
4. Extend Duration on Payments - Another way for small businesses to improve their cash flow management is by negotiating payment terms with suppliers and vendors to extend the duration of the payments to smooth out cash flows.
5. Track Expenditures - Small Businesses should track expenses to identify areas where costs can be better managed, thereby improving cash flow management.
6. Improved Forecasting - Businesses can improve their cash flow management by creating precise financial projections and comparing them with actual results.
7. Revamping Revenues - A business can reduce risk to its cash flows by adding multiple business streams rather than relying on a single customer or market. The approach will help enhance the overall stability and resilience of the company.

Conclusion

It's no secret that over two-thirds of small businesses face financial challenges, with budgeting and cash flow management being the most significant pain points. However, businesses need to understand that by employing the right tools and strategies, they can mitigate the challenges, making their journey smoother and more successful.

Regular monitoring and tracking of in-house cash flows and staying abreast of developments in the market are critical to improving cash flow management and making informed decisions. With sound strategies and practices in place, small business owners can successfully navigate the complexities of the marketplace and reach their financial goals.