Cash flow is just as important as generating a profit. If your business has difficulty generating cash inflows, managing cash may be more important than profits.

Consider this quote from The Balance: “Cash is the single most important element of survival for a small business. Small businesses often say that an inability to control cash is their single biggest problem.” This article explains the factors that impact cash flow, and the steps you can take to improve cash inflows.

You can fix the cash flow problem and also maintain business profitability. Start by taking a step back from your business and reviewing these four concepts.

Four terms that measure business value

These four terms are not found in your financial statements, but they each impact your company’s profitability and cash management. Read through these terms, and think about how they apply to your business:

Increasing customer lifetime value

Customer lifetime value (CLV) measures how valuable a customer would be, assuming that the client purchased products or services over an unlimited amount of time.

For example, everyone needs a reliable auto mechanic. If a customer spends an average of $400 a year, and the repair shop operates for another 20 years, the CLV is $8,000.

If you can increase CLV, you can operate profitably with fewer customers. As long as the repair shop keeps the same customers coming back each year, it can spend far less on marketing. Lower marketing expenses allow the business to conserve cash.

Lowering customer acquisition cost

Customer acquisition cost (CAC) is the expense incurred to convince a customer to buy a product or service for the first time. Online businesses track the number of times a prospect visits the website before they make the first purchase.

The faster a client buys, the less money is spent to maintain the website and to post interesting content. If you can acquire new customers in 30 days instead of 90 days, the marketing costs to obtain a customer are much lower.

If you can lower your CAC, each new customer will require less cash for marketing expenses.

Speeding up the sales cycle

CAC measures costs, while sales cycle measures time. The sales cycle represents the activities required to close a sale. A grocery store’s sales cycle is very short, because customers go to the store every 10 days or so. Cash payments are processed immediately, and credit card or debit card payments are received quickly.

Businesses with short sales cycles can operate with less cash, and collect payments faster. If you can speed up the sales cycle, you’ll speed up cash inflows.

Assessing monthly recurring revenue

Monthly recurring revenue (MRR) is the amount of income that a firm can reliably anticipate every 30 days. The more repeat business you can generate, the less you’ll need to spend on marketing for new customers.

Now that you’ve considered the four concepts, let’s define liquidity.

Why liquidity is important

Liquidity refers to your firm’s ability to generate enough current assets to pay current liabilities.

Current assets include cash, and assets that will be converted into cash within 12 months. Your two biggest current asset balances may be accounts receivable and inventory.

  • Accounts receivable is a current asset account, because you expect to collect all customer payments within 12 months.
  • Inventory is also a current asset account. You expect to sell inventory on hand and convert sales into cash within a year.

Current liabilities are bills and other debts that must be paid within 12 months.

If you can’t generate enough cash flow to operate each month, it’s likely that you have a large amount of cash tied up in accounts receivable or inventory (or both). So, what, specifically, can you do to improve cash flow?

Strategies to improve cash flow

Generally speaking, you can improve cash flows by speeding up your entire sales process. A retailer, for example, purchases inventory, markets products, sells goods, and collects payment. To collect cash faster, the retailer needs to move through each step in less time.

You can’t generate profits if you don’t have products on the shelf.

Understand your inventory needs

Every company should plan for an ending balance in inventory at month end, which allows the business to fill customer orders in the first few days of the next month. Many businesses don’t carefully plan for inventory purchases, and these firms risk the loss of a sale if inventory levels are too low.

For formula for ending inventory is:

(Beginning inventory + purchases – sales = ending inventory)

Ending inventory is often based on a percentage of monthly sales. Use the ending inventory formula to ensure that you maintain a sufficient amount of inventory. Next, plan the cash outflows to purchase inventory.

Be direct when you ask for customer payments.

Create a formal process to ask for payment

Firms that do not closely monitor accounts receivable and enforce a formal collection policy may not generate sufficient cash inflows to operate. Here are the two most important steps:

  • Your accounting software should provide an aging schedule for accounts receivable, which groups your receivables based on when the invoice was issued. You should monitor this report.
  • Implement a collections process to email and possibly call clients to ask for payment. The aging schedule will tell you which clients need collection follow up. If you get pushback on payments from customers, consider not doing business with them going forward.
  • Offer your clients a discount (1% to 2%), if they pay within 10 days. You’ll lose some revenue, but you’ll collect some cash faster.

The best resource for cash management is the bank reconciliation.

Reconcile the bank statement quickly

Reconcile your bank account within a few days of downloading your bank statement. The reconciled bank balance is your starting point for cash, and you can’t generate an accurate cash flow statement without the balance.

These are the steps required to collect cash inflows so you can operate your business. So, where do you go from here?

Cash flow and profit

The steps explained above do not impede your ability to generate a profit. You have the option to increase your prices, add new products and services, and to cut expenses. Resolving your cash flow problems does not have to impact your profitability.

Managing a successful business requires you to manage cash and generate a profit. Put these steps in place to improve your cash flow, and to have more peace of mind.