Small Business Cash Flow Forecasting. Tips & Strategies for Managing Cash Flow.

For small business owners throughout the country, talking about “the Economy” is a regular subject. From oil prices, to food costs, when the interest rate will creep up again, or what the housing prices look like in the coming year. People engage in these talks because, more often than not, it directly impacts their job security, income, and net worth, and… it’s also just fun to talk about. While “the Economy” can be a subject of small talk for some, it should be a serious topic for all small business owners.

Although macroeconomic fluctuations may not be directly felt by small business owners, major economic shifts such as the Great Recession during 2007-2009 can be detrimental to local small businesses. Consumer spending is curbed, funding is tightened, and a vicious cycle of unemployment pans out. Needless to say, we’ve witnessed numerous companies small and large, new and old, close their books and disappear into history. Fortunately, many others survived the downturn and are thrived during the bullish market that followed. What did they do right?

Though there is no one answer to the question, businesses that prepared themselves to swiftly adapt to the changing environment fared the best. That is, even for small business owners, those who did their homework in performing sensitivity analyses (creating 3-4 business scenarios in the short and mid-term), and maintained a healthy brand equity, rose to the top. 

More than anything, however, small businesses must be prepared to fuel their business with operating cash flow during these economic downturns. It is always sound practice to have access to capital, even if you are not using it during during the “good times”. By planning at least the worst, average, and best case scenarios for the near future, small business owners can minimize damage from external influences, while maximizing opportunities during upward momentum.

The old adage “cash is king" still carries weight when it comes to effectively operating and growing a small business. It's essential to maintain operating cash to fund the daily operations of your business, but cash reserves beyond that can be viewed as capital that can be used to fund growth or reinvestment in the business.

Before even entertaining the question of cash versus credit, you should make sure you have a clear picture of what operating cash you need to comfortably run the business.
Decisions in the present are often easier to make when viewed with a keen eye toward the future. To that end, developing and frequently updating a strategic business plan that clearly identifies where you aim to take the business, as well as key milestones along the way, will help determine the most effective approach to funding growth. Do you hope to sell your business in the next five years? Or do you want to build a lasting enterprise that will steadily grow and be passed on to your children? What other financial factors, such as funding college education or your ideal retirement horizon, may impact how aggressively you grow? These can be challenging questions, but ones that can provide valuable insight into how you approach and fund growth. 

It can take time to see a business develop, but with the right amount of growth capital, that development is certainly possible. Too many business owners fail to understand the difference between working capital and growth capital, which can mean that they don’t spend enough time developing their growth capital the way they should. When it comes time to expand the business, there isn’t any money available for that expansion, so the business can’t develop the way it needs to in order to keep up with the competition. That can have devastating effects on a company that would otherwise be very successful, and it’s something any company needs to avoid.

When assessing how to fund growth, it's essential to calculate how much debt you're already carrying and your comfort level adding to that debt. If you have sizable debt, additional borrowing could have a negative impact on your credit rating, which is never a good position for a small business. And your ability to secure a loan and get favorable terms will be partly dependent on existing debt as well as other elements of your financial and business profile. If you're carrying a manageable amount of debt and can secure a loan or line of credit at competitive rates, then credit may be the best option. However, if your debt level makes you or your lender uncomfortable, then perhaps establishing the discipline of using cash to methodically fund growth of your business could make the most sense.

So... What Is Growth Capital?

Unlike working capital, which is used for bills and basic, cyclical expenses, growth capital isn’t tied to any particular business cycle. Instead, growth capital is designed to provide long-term health for the business. It builds up over time, and can ensure the business’s well-being. Once a business decides that it is going to make a major change, like an expansion, adding another location, or a merger with another company, growth capital will come into play and be used. These kinds of changes are very expensive, but they are not recurring expenses that are going to be seen every month. Since they aren’t recurring, they don’t come out of working capital.

Without a growth capital fund to pull from, however, a business can’t really accomplish anything beyond its day to day operations. There will not be any expansion when there isn’t any growth capital to use, this generally comes about from poor financial planning and can be profoundly damaging to a small business.

Are you a startup (under 2 years in business) or a seasoned business? Many find themselves in a catch-22. They don't have deep cash reserves for capital investments, but also face challenges securing credit because they lack a track record of profitability for their business. In this instance, the most prudent action may be a hybrid approach in which cash is supplemented by funds available through a modest line of credit, or, in some instances, a credit card with manageable interest rates. This approach creates discipline while also allowing for the flexibility of tapping credit when the opportunity is right.

Ultimately, how you finance the growth of your business will come down to a range of factors, and will likely change as your business evolves. Yet by taking a thoughtful and methodical approach, you can improve your opportunity to take the most efficient and cost effective path to growth.