How Small Businesses Can Avoid Negative Cash Flows

March 1, 2024

An image of a small business owner reviewing their cash flow after speaking with their local Toronto accountant.

What is the most important thing every new entrepreneur needs to start a business? Revenue, profits, cash, capital? Every business begins with cash. Whether you want to sell fried chicken or become a market consultant, you need initial cash to buy raw materials or spend on marketing to get the word out. Regular cash flow is the fuel that keeps the business going. Many businesses fail as they run out of cash and fall into the negative cash flow spiral. While occasional cash shortages are expected, staying in this situation longer could be fatal. A business that doesn’t pay its employees, suppliers, debtors, shareholders, and owners on time loses its reputation and accumulates poor credit scores. 

Hence, business owners must do everything possible to prevent negative cash flow from becoming chronic. This article will discuss the precautions small business owners can take to avoid negative cash flow. 

Create a Cash Flow Statement 

Famous value investor Warren Buffett said, “Risk comes from not knowing what you’re doing.” Doing business with people who are blind can be dangerous. Hence, the first step is to know your cash situation and stay updated. You can begin by building a cash flow statement from Day 1 to implement this step. 

A cash flow statement tells you how the cash flows between the income statement and the balance sheet. Since your business does not have a history of income and expenses, it is time to write this history. Record all your cash transactions under the relevant categories: 

  • Investing cash flow shows the capital you spend on buying inventory or assets or the money received from selling them.
  • Financing cash flow shows the money you raise from debt and equity to invest in the business and the interest you pay on the loan.
  • Operating cash flow shows business income earned and the cash spent to perform the operations. It includes client payments and payments made to creditors, suppliers, and employees.

For instance, John buys a delivery van for $46,000 using a debt of $40,000. The cash flow statement will report a $40,000 cash inflow in financing (loan), $46,000 cash outflow in investing (asset purchase), and cash outflow from operations (maintenance and fuel). 

Use Cash Flow Statements for Planning and Budgeting 

Once you have at least a month’s data, you can create a cash flow forecast for the next month, adjusting the amounts for any seasonality. When planning your budget, you start with the cash in hand and add the expected cash inflow from the invoices prepared for the month. You can deduct the regular fixed overheads and set aside some amount for variable overheads. 

Once you know your operating cash balance, you can determine how much cash is available for long-term investments like business expansion, asset purchase, or any other significant expense you had planned. This way, you always have your cash position handy and can plan your next business and financial decisions. 

For instance, you plan to open a new store. Since you have the financial data readily available for your current store, you can make a budget for the new store with some degree of accuracy. Also, you can plan the sources to raise funding. If you seek a business loan somewhere in future, start preparing early and build your business credit score with business credit cards and short-term loans. 

When financial planning and budgeting use historical data as the base, the cash flow gap narrows, and you can avoid making expensive cash flow mistakes. 

Review Outgoing Expenses Regularly

While using cash flow for planning and budgeting, you should consider comparing your actual and estimated cash flow statements. Initially, the gaps between actual and estimate would be more expansive. But they will gradually narrow as you perfect your forecasting.

It is essential to regularly review your cash flow as the numbers will tell you in advance where there are cash leaks. Negative cash flow generally occurs due to structural faults or excessive spending.

Pricing and Overhead Cost: When reviewing your cash flow statement, if the operating cash flow turns negative despite rising revenue, there could be a fault in the pricing or cost structure. Either you have priced your goods low because of which sales cannot meet the cost, or your overhead costs are too high. Through a cash flow review, you will know where to look and devise a solution accordingly. If increasing prices is not an option, you can segment your product into premium and standard. Or else you can look for other suppliers that can give you quality goods at better prices.

Customer Payments: If negative cash flow is because of delayed payments by a particular client, you can discuss some alternatives with the client. Sometimes, a regular follow-up or a different payment option (online/credit card) can do the trick.

Overspending: Another common cause of negative cash flow is going over budget with marketing expenses or aggressive hiring. Reviewing and updating your cash flow estimate with every monetary decision can keep you in check for your negative cash flow. 

Contact DNTW Toronto LLP to Help You with Cash Flow Planning 

A professional accountant can help keep your books updated and flag the areas that need your attention. To learn how DNTW Toronto LLP can provide you with your accounting, bookkeeping and cash flow planning, contact us online or by telephone at 416.924.4900