As a small or growing business you likely have periods of low cash flow — where there’s no cash at hand, bills are waiting, and you want to avoid loans.
What you’ll learn in this article:
Most healthy small business that are profitable still have periods of low cash flow. And understanding where your cash flow challenge happens is the first step to managing cash flow in your business more effectively.
These are the most common reasons cash flow in business gets low at times:
And the list of cash flow management challenges goes on.
First, let’s discuss your margins.
How much should you be making to be profitable, (even after the interest on your line of credit)?
Most healthy businesses have money coming in consistently – “cash flow turn” and gross profit margins ranging from 35-45%. Of that, 15-20% goes to operations, and then you have the remaining 10-15% as profit.
So, what should your margins be for a business line of credit to be worthwhile?
If your low cash flow is a one-time event, avoid loans or the interest on a credit line by offering deals to vendors or customers. For example, give them an early payment discount, or offer a great deal on current or future inventory.
Does low cash flow in your business happen several times a year?
Check your margins before using a credit line:
Disclaimer: Of course, as your business grows, this ratio of revenue and expense will change, and business expenses will vary in proportion to your needs. 30% is a good target, but not always the answer for all businesses.
When applying for a line of credit, banks will check cash flow in business by looking at how effective your operations are, and so should you.
How long is your inventory parked without being sold?
How much do your customers owe you?
Be smart. Manage your cash flow and operations to make the right decisions — how much to borrow, for how long, and on what terms.
A smart way to approach this is to be very clear about how you’ll use the funds and repay them — before applying for a business line of credit.
Here are a few questions to ask to avoid overborrowing:
If you answered “yes” to question two (or can see this “investment” returning value in a few months), look at your working capital and calculate fundamental financial ratios. Now you can calculate how often your cash flow is turning — money going in or out. And that will help you navigate question 3 – when will that profit hit my accounts again — in cash?
As a general rule, to avoid most overborrowing problems, you should use less than 30% of your total limit. Keeping in mind that you want to pay off the balance each month to maintain your credit score.
Lastly, remember to include the paid interest as an expense. A line of credit is a business expense and should be included as your operating or financial activities in your cash flow management.
Pro tip: To help repay the business line of credit and avoid poor cash flow while you repay, keep this credit line interest expense in mind when you price your future products.
Morris Reichman is the founder and CEO of Payro Finance. Former Vice President at Infinity Capital Funding an alternative finance company, Morris possesses a versatile background in the finance industry. Having spent 7+ years working across global macro operations and start up corporate finance Morris's expertise is in business accounting, risk management and investment analysis. Morris founded Payro Finance to support business owners and ensure their business continuity.