In a previous post I discussed how customer acquisition costs would bankrupt any business if they exceeded the lifetime value of customers. If what you’re paying to attract and keep customers outweighs what they’re paying to be customers, then you’re losing money. A sustainable company must have profitable customers.
But profit alone does not a successful business make. You also need a healthy cash flow. The calculator may reveal that your customers turn a profit after two years, but do you have the cash to cover your operating costs while you wait to break even? Profitability won’t save you when the bills come due and the well runs dry.
Poor cash flow forces many small businesses to close their doors, and even profitable businesses sink when their cash runs out. You just can’t keep the lights on without cash.
The concept is straightforward enough, but the implementation is where businesses get hung up. Just like profitability, cash flow is affected by several variables, and only when the root causes of a poor cash flow are identified will the solution be made clear. Cash flow forecasting is the “crystal ball” that provides insight into what’s hogging your money, so that’s where we’ll start.
Biggie Got It Wrong

The Notorious B.I.G. must’ve not known about cash flow problems
The first step in addressing any issue is recognizing its true, underlying problems. If a cash shortage issue is a one-time occurrence (like in the case of business start-up costs), then a loan may be the perfect solution. But if maintaining a healthy cash flow is an on-going issue, then a loan would only offer temporary relief until the money ran out again.
Coming up short on cash is actually a symptom of a number of possible problems, all of which can be accurately diagnosed with cash flow forecasting. So we’ve created a cash flow projection tool that you can use to identify what’s tying up your money and how to make improvements to your cash flow.
We’re all about practical application, so we set out to make this a truly valuable calculation tool. The biggest difference between our cash flow projection template and others out there is that we’ve already done the heavy lifting for you. We’ve included calculations for when cash is collected from sales made on credit terms, and we even included calculations for cash realized from delinquent accounts.
I understand that it may have been awhile since your last accounting course, so here’s a quick breakdown of the components that make up a cash flow projection:
- Credit terms – an agreement concerning the timing of payment for services
- Delinquency terms – an agreement concerning the timing of payment for services after the credit terms
- Accounts receivable – money owed to a company by its debtors to be collected within the credit terms
- Delinquent accounts receivable – accounts receivable uncollected past the credit terms to be collected within delinquency terms
- Uncollectible accounts receivable – accounts receivable remain uncollected past the delinquency period that are written off as bad debt
- Cash sales – sales in which the buyer makes immediate payment upon services rendered from seller
- Credit sales – sales in which the buyer agrees to make payment for services rendered within the credit and delinquency terms
- Cash inflow – for our purposes, cash inflow is strictly defined as money received as a results of sales and financing (liquid cash is what we’re talking about here)
- Cash outflow – money paid out for any reason
Now that we’ve got the terminology out of the way, go try out the online version of the tool; fill in your costs, sales, and collections projections and then play with the variables to see what has the biggest impact on your cash flow. Of course, you can always download the cash flow tool as well:
And while you’re tinkering around, let’s take a deeper look at the obvious and not-so-obvious effects of manipulating those variables.
If this, then that…
When adjusting the inputs in the cash flow tool, it’s easy to get prematurely excited about some of the positive results, “Wow, decreasing my credit terms by 5 days cures all my cash flow problems!” But before making any decisions, it’s important to understand some of the possible unintended consequences that cannot be reflected in the cash flow projection.
Shorten Credit Terms
Decreasing the collection period for credit sales may seem like a great way to get your cash faster, and it might be, but don’t turn a blind eye to some of the potential negative side-effects.
Credit terms may be a huge deciding factor your customers use to decide with whom they do business. Remember: healthy cash flow is important to your customers, too! This is why it’s so vital to understand your customers and why they choose to work with you over your competitors. If your generous credit terms are a huge reason customers pick you, then changing those terms could mean losing a significant portion of your business.
Next, what’s the industry standard for credit terms? If 30-day terms are expected and you only offer 15-day terms, then potential new customers may pass over you when they are shopping for providers. Keep in mind how your credit policy may impact sales and acquiring new customers.
Finally, don’t forget that you can only collect payments to the same extent that you can enforce your policy. Shorter terms may help bring cash in faster, but they may also result in fewer timely payments and more delinquent accounts. To avoid writing these accounts off as bad debt, you must establish protocols and hire employees to follow-up with customers who have outstanding balances. Some businesses prefer to outsource this function to collections agencies, but the bottom line remains the same: it costs money to collect money. And this may go without saying, but I’ll risk looking like captain obvious and say it anyway: don’t spend more money to collect payments than what the payments are worth!
Give Discounts for Timely Payment
In theory, payment discounts will result in more customers paying on time, but “theory” doesn’t always pan out in “reality.” Just like making changes to credit terms, before you pull the trigger on payment discounts you must thoroughly understand your relationship with your clients. Is a discount important to your customers? Would your customers take advantage of a payment discount if you offered it to them? If so, approximately how many?
While you can never know exactly how customers will behave, you can certainly know your customers. Understanding your customers well equips you with powerful information that should give direction to the decisions you make.
If your customers aren’t at all motivated by discounts, then your efforts to encourage early payments will fall flat. On the other hand, if your customers are extremely motivated by discounts, then even a small payment discount may be all the help you need to fix your cash flow.
Incentivizing customers to pay on time may help alleviate the “need cash now” crisis, but keep in mind that discounts will also eat away at your revenue. How much revenue can you feasibly give up in exchange for timely payments? Use the projection tool to experiment with discounts and determine a target for the percentage of accounts receivable you’d need to collect to resolve your cash flow problem.
Finding a proper balance between the discount and projected collections has huge implications. Overestimating how much your collections will improve will leave you still waiting for the cash you need, and underestimating how many customers will take advantage of the discount will leave you with less cash than you need. If you implement a payment discount without exploring its likely impact, you’re just asking for trouble.
Reduce & Delay Cash Outflows
While improving inflows may offer a bigger bang for your buck, don’t discount the role that minimizing outflows can play in freeing up your cash. Sift through your expenses with a fine-toothed comb to see where there’s room for improvement. If you come across any luxury expenses, start dropping the ones that only affect you, as the owner, first. Maybe that means fewer business conferences, less money budgeted for company meals, or even a temporary salary cut until your cash is in good order.
The next step is to explore the possibility of renegotiating your terms with suppliers. Have you proven your trust with suppliers by reliably paying on time? Do you have a long history with your suppliers and established a strong relationship with them? Don’t be afraid to discuss credit terms with suppliers; the worst thing that can happen is they say no. But before you approach suppliers, you have to know what new credit terms to negotiate. Use the cash flow forecasting tool to push your expenses back and experiment with different payment terms; how many additional days would you need to fix your cash flow problem?
If you are, in fact, able to extend your credit terms with suppliers, then immediately make it a goal to work your way back towards the original terms agreement. When suppliers extend credit terms, they are actually transferring your cash flow burden onto themselves. When you eventually get a sure handle on your cash, offer to return to the old credit terms. This will go a long way for your relationship with your suppliers, plus it’s just the right thing to do.
Cutting back on employee perks or benefits should only be considered a last resort. While some of these expenses may seem frivolous (free lunches, the well-stocked Keurig, company happy hours, etc.) it’s important to consider the effect that their removal may have on morale and productivity. Before touching these expenses, always exhaust every other option first. And if it is unavoidable, be honest with your employees so they know the situation. Hopefully they’ll understand that coffee can’t be on the house until the cash flow is back under control.
Prevention and Preparation

Don’t be caught unprepared!
In addition to the three aforementioned cash flow improvement strategies, there are also certain measures you can take to help prevent cash flow issues and quickly address them when they crop up in your business (notice I said when, not if).
No one ever plans on having a poor cash flow, but it happens all the time. All it takes is one unexpected expense, one bad month in sales, or one delinquent account to derail the money train. Protect yourself by preparing for the worst and mitigating damage when cash gets tight.
Build Cash Reserves
Storing up an emergency fund should be the first order of business for any organization (and family, for that matter). Exercise some discipline and build your cash reserves rather than buying any toys or even investing back into the business. How much to save before you can start re-purposing profits depends on the nature of your business and the risk involved. However, as a rule of thumb for an emergency fund, three month’s worth of operating expenses is a good place to start.
The goal of cash reserves isn’t so much to address the root cause of a cash flow issue as much as it is to buy you time to continue operations while you diagnose and resolve the underlying problem. Using the cash flow projection tool will help you quickly hone in on specific areas to free up cash, but it will likely take a few months to actually reap the rewards of those efforts. The effects of renegotiating credit terms, offering discounts for early payments, and shortening your own credit terms won’t be realized overnight, so you’ll need cash savings to float you along until you right the ship.
Create Custom Credit Terms
Sometimes a “one size fits all” doesn’t actually fit. When it comes to the credit you offer your customers, you may find it beneficial to customize your terms based on each customer’s credit history rather than treating every account the same way. Develop a rubric to grade your customers’ credit and assign specific credit terms commensurate with their scores.
Extending credit to customers is taking a risk. Be wise in the amount of risk you assume by vetting your customers before dispensing credit. Offer generous terms only to those who have demonstrated their reliability and use shorter terms to guard yourself from customers who haven’t yet proven themselves. As customers show they are trustworthy, you can always choose to reward them with better terms if you so desire.
Establish Follow-up Protocols
We’re all busy people, and for some (not so) odd reason, settling debts never seems to be a top priority. So, when it comes to paying bills, a friendly reminder (or two!) can only help. Plenty of accounting software (like QuickBooks, for example) is equipped to send automatic invoice reminders to customers at designated time periods. Take advantage of such tools to help your clients stay on top of their bills and pay you in a timely manner.
If you discover that canned email responses only improve bill payments so much, then you may consider following up by phone as well. Some customers require more handholding than others, and if what you stand to collect justifies the extra effort, then by all means schedule the time to call your customers before they become delinquent. In fact, you may want to assign certain tiers of follow-up protocols that are directly related to the credit score you give them. The riskier the customer, the more intensive the follow-up procedure must be.
Take Action

Don’t succumb to analysis paralysis!
While there are several possible cash flow solutions available, it’s important not to succumb to analysis paralysis. There’s no time for hesitation when you’ve run out of cash. If you don’t already forecast your cash flow, download the tool and start today! And if you discover a potential cash flow issue down the road, start playing with the input variables in the tool to find out where you can make the biggest impact in your circumstance. Don’t wait until you’re face to face with a cash flow problem to address it – by then it might be too late!
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