How to improve cash flow for small businesses in 7 steps

When building a small business, cash flow management is crucial for monitoring your income and expenses.

From sending invoicing to optimising inventory, tracking your money gives you the financial stability to run a successful business. It helps you set small business budgets, make informed financial decisions and ensure you have enough money to cover your costs.

If you’re ready to take control of your money, we’ve put together a guide on how to improve cash flow as a small business. Discover common cash flow mistakes and learn strategies to increase your income.

How to improve cash flow in your small business

Cash flow refers to all the money that moves in and out of your business.

This includes revenue from sales, small business loans and investments, as well as outgoing payments such as operating costs, supplier costs, payroll, and taxes.

Understanding and managing cash flow is important for all merchants as it provides a clear understanding of the financial health of your small business. It can be used to highlight whether you have enough funds available to cover obligations, invest in growth opportunities and maintain business continuity.

Positive cash flow

A positive cash flow occurs when more money is coming into your business (your income) than you have going out of it (your expenses).

A sustained period of positive cash flow can lead to an increase in your overall business profits, making it a financial goal for many small businesses.

Negative cash flow

A negative cash flow occurs when your expenses outweigh your income. You might struggle to pay your bills and cover small business expenses due to insufficient funds, leading to financial insecurity.

When looking at how to improve cash flow, there are a number of factors to consider which we’ll look at in this guide, including:

• The different types of cash flow for small businesses.

• Common cash flow problems.

• How to improve your invoicing process.

• Managing your small business budget and diversifying revenue.

• Using cash flow software and tools.

3 types of cash flow for small businesses

When it comes to how to improve cash flow as a business, it’s beneficial to learn the 3 main types.

Not only does this give you a cohesive overview of your income and expenses, but it’s also required when producing a cash flow statement - a financial document that details the cash flow throughout your business.

In your statement, operating cash flow is always listed first. Following this, you'll list your investing cash flow and financing cash flow.

Operating cash flow

Operating cash flow describes your income and expenses from regular business activities, excluding any long-term investments and financing.

It’s a calculation of your core business transactions, making it useful for merchants looking into how to improve short-term cash flow. Any long-term revenue and costs are disregarded.

From manufacturers to retailers, many businesses use operating cash flow to present a realistic picture of their day-to-day financial health. To calculate yours, follow this formula:

Your net income is the revenue you earn minus any expenses.

Non-cash charges refer to expenses that don’t involve a transaction, including depreciation, depletion and asset impairments.

Working capital describes the costs associated with day-to-day operations.

Investing cash flow

Investing cash flow refers to any long-term expenses or income generated from investment activities.

Negative investing cash flow expenses include:

• Buying fixed assets.

• Investing in stocks and marketable securities.

Positive investing cash flow income includes:

• Selling fixed assets.

• Selling your stocks and marketable securities.

• Money received in interest payments.

To calculate your investing cash flow, deduct your total negative cash flow from your total positive cash flow.

Do note that a negative investing cash flow isn’t always a sign of financial instability. It can indicate that you’re harnessing growth opportunities in order to scale your business, for example.

If these lead to increased profit, your negative investing cash flow will have been beneficial for your small business finances.

Financing cash flow

If you need funds to finance your small business, these transactions will be recorded as your financing cash flow.

This refers to the money that moves between your business and your owners, shareholders, investors and creditors.

For example, you might have taken out a small business loan. Any payments you make towards this debt will be counted as financing cash flow.

Paying yourself as a business owner can also be included in this category if you withdraw directly from business profits as a distribution of equity.

Calculating your financing cash flow produces key insights into your business’s financial health and how you manage your capital. It’s also essential when valuing your business.

To calculate your financing cash flow, use the formula:

• CED refers to incoming cash flow from debt or equity (cash inflow).

• CD refers to transactions paid as dividends (cash outflows).

• RP refers to any repurchased debt or equity (cash outflows).

Common cash flow problems to be aware of 

When looking at how to improve net cash flow (the total cash flow for your business), understanding common problems can help you identify your existing financial issues.

You’ll also learn what not to do when managing cash flow, improving your financial confidence.

To get started, we’ve put together some of the common cash flow problems that you should be aware of as a small business owner.

Narrow margins

When your income and expenses are too closely matched, you leave little room for fluctuations in either. If your income drops or your expenses increase, you may not be able to cover your business costs.

Over-reliance on a few customers

Relying on a few customers can lead to problems if one or more reduce their purchases or stop using your products or services altogether. Would you have enough income to maintain business operations?

Clients who pay late

Late-paying clients can disrupt your cash flow, especially if you rely on incoming payments to cover your expenses. This is also true for clients who never pay, leading to lost revenue and financial strain on your small business.

Too much inventory

Overbuying inventory can create liquidity problems, in which you can’t quickly sell your stock to access funds.

Overestimating your cash flow forecast

Predicting a higher income than you actually earn creates business risks such as overspending, unplanned working capital shortages and an inability to meet financial commitments such as loan repayments. Instead make conservative and realistic cash flow forecasts to avoid this common pitfall.

Rapid expansion

If you increase business growth expenses too quickly, your costs may rise faster than revenue, putting a strain on your small business finances.

7 steps to improving cash flow in a small business

Whether you sell craft supplies through an online store or run a holistic yoga studio, managing your cash flow is crucial for the sustainability of your small business.

Learning how to improve cash flow in a company, however, can be difficult. To help you get started, we’ve put together 7 steps for effective cash flow management.

Improve your invoicing process

Reduce invoicing errors, speed up incoming payments and track your revenue with an efficient invoicing process.

Let’s say, for example, that you start a side hustle mowing lawns. When you send out invoices, you can better manage your cash flow by:

• Adding a payment term of 7 days to the invoice.

• Adding late payment fees into your initial agreement.

• Tracking your invoices on a spreadsheet or through invoicing software to identify when a payment is late.

These steps give you a clearer idea of when you’ll receive your payment, helping you financially plan ahead. They also reduce the risk of late or missed payments for your small business.

Manage your expenses

If you’re looking at how to improve operating cash flow, one solution is to reduce your expenses.

This can be simpler and quicker than increasing revenue, depending on your business and current financial situation.

Reducing your expenses doesn’t mean having to go without. Instead, you can look at reducing the costs of your purchases.

For example, if you sell hand-sewn hair scrunchies, strategies to look into include:

• Buying cheaper offcuts of fabric instead of full metres. This would also add a sustainable aspect to your business for a clear unique selling proposition (USP).

• Renegotiating prices with your suppliers or taking advantage of loyalty deals.

• Opting for bulk buy offers. Though they lead to an increase in short-term costs, they’re beneficial if you’re planning how to improve your cash flow position in the long-term.

It’s also important to review unnecessary spending. For example, if you’re paying extra for pink envelopes to ship your scrunchies, consider cheaper alternatives. A standard envelope with a branded pink stamp, for example, could be more cost-effective.

For other business models, additional expense management methods include:

• Creating payment plans with suppliers or lenders to reduce the strain on your cash flow.

• Avoid making payments early to prevent issues from unexpected expenses.

• Hiring equipment or materials you can return.

Diversify your revenue streams

Diversifying revenue entails finding opportunities to bring extra income into your business. This reduces your reliance on your main source of revenue, helping:

• Mitigate cash flow risks associated with seasonal fluctuations.

• Attract new segments of your existing audience to expand your customer base and increase sales.

• Improve resiliency in the face of financial challenges such as economic downturns and inflation.

• Generate increased profits to improve your financial stability.

Let’s say that you’re looking at how to improve operating cash flow as a mobile hairdresser.

You could look into offering hairstyling for events, too, and increase your bookings. To reach a new target audience, you could carry out a nail technician qualification to offer both hair and nail services.

Upselling and cross-selling

If you’re looking to increase your revenue to improve your cash flow, upselling and cross-selling are two strategies to consider. Let’s take a quick look at each.

Upselling

Upselling encourages customers to upgrade their current product or service.

For example, if you own a cocktail bar, you could ask 2 customers if they’d rather order a jug than 2 separate glasses. This is more cost-effective for the customer and increases your average order value.

Cross-selling

Cross-selling involves suggesting add-ons for the product or service the customer is purchasing.

If you own a fast-food restaurant, for example, you can use kiosks to automate cross-selling when the customer pays. Showing drinks or side dishes that complement the food they’ve already selected not only improves the customer experience but also increases your average transaction value (ATV).

Cross-selling also works as an online technique. When a customer checks out through your online store, you can display similar or complimentary items before they complete their order.

New client checks

Due diligence can reduce the risk of missed or late payments for your business. This is particularly important when accepting orders with a high value or extending credit to the client.

In this case, you might be able to use an agency to run a background and credit check. Your check will highlight potential risks, such as if the client has ever declared bankruptcy or faced legal prosecution for a financial dispute.

To mitigate risks, you can also request a deposit before final payment and processing an order.

Let’s say that you’re an artist and you sell personalised pet portraits. Before accepting a customer’s commission, you can ask them to pay a 25-50% deposit to cover your expenses. Once the painting is delivered, the customer will be required to pay the rest of the bill.

Optimise inventory management

Inventory management can help merchants looking into how to improve cash flow in a manufacturing business. It’s also useful for small businesses who:

• Order products to sell.

• Order materials to make their products or deliver services.

As a restaurant owner, for example, you’ll use inventory management to track the ingredients needed to prepare the food on your menu.

In terms of cash flow, optimising inventory gives you access to money that would otherwise be tied up in your stock. It also improves your liquidity, allowing you to turn existing stock into money quickly.

The right amount of inventory reduces the risk of understocking, too, so that you can meet customer expectations and prevent loss of sales.

Plan in advance for seasonal fluctuations

When looking at how to improve negative cash flow caused by seasonal fluctuations, focus on preparation.

Fluctuations can be unavoidable in certain businesses. If you rent water sports equipment at a lake, for example, you’re likely to be busier in the summer than in the winter.

In these lean periods, it’s vital that you have a cash reserve. This is a fund you set aside for expenses that you can’t cover with your incoming revenue, making it easier to meet costs during times of negative cash flow.

Adjust your marketing or sales strategy, too, if seasonal fluctuations are a recurring problem. Look into diversifying your revenue stream as we discussed earlier in the article, or widen your business model to avoid negative cash flow.

For example, as the merchant renting sports equipment, offering winter-themed parties using your sports equipment could mitigate fluctuations. You might also use advertising to highlight the physical and mental health benefits of exercise in the winter.

How to predict seasonal fluctuations

Having a clear understanding of seasonal fluctuations makes you better prepared to face them. To learn more, we recommend:

• Conducting market research that looks into seasonal industry trends.

• Using online data (such as UK economic activity reports which provide a broader look at nationwide spending fluctuations).

• Conducting a competitor analysis to understand how similar businesses shift their marketing strategies to reflect fluctuations.

• Reviewing your past sales to identify seasonal patterns.

Your business’ historical data is a brilliant starting point when predicting fluctuations. It’s specific to your business model and target audience, and can help you identify which seasonal marketing campaigns produced an increase in revenue.

Financial tools that can help with cash flow management

Software and accounting tools for small businesses can simplify your cash flow management and speed up tasks. Some different tools to consider for your financial management include:

• Cash flow forecasting: Use software that analyses your financial history to create instant cash flow forecasts.

• Financial dashboards: View a real-time overview of your cash flow with financial dashboards, like the SumUp business account. Track your upcoming payments, monitor invoices and access past financial data from one cohesive platform.

• Loan management: Simplify loan repayments with tools that track your schedules and calculate interest, helping you make informed decisions around financing and debt repayment.

• Predictive analysis: Utilise the power of artificial intelligence (AI) with predictive analysis. This software analyses your financial data to predict future cash flow and offer insights into how you can better manage your money.

You can also choose business tools that integrate with cash financial software, monitoring your money in real-time.

A card reader, for example, can be connected to your business account and invoicing software, automatically recording payments for simpler cash flow management.

Disclaimer: The contents of this page are intended for informational purposes only and should not be construed as professional advice. For matters requiring legal or financial expertise, it’s recommended to seek guidance from qualified professionals.