Essential strategies for cash flow management for SMEs

Small business cash flow management: at a glance

• What do I need to know? Effective cash flow management strengthens your balance sheet by improving liquidity and building cash reserves.
• What does it mean for me? Real-time monitoring of inflows and outflows can help you to forecast shortfalls and bridge gaps in cash flow before they arise.
• Why does it matter? A consistent and resilient cash flow builds investor confidence by demonstrating predictable income streams and low financial volatility.

While profit is a marker of long-term success, cash flow keeps your business running day to day.

For growth-phase businesses in particular, cash flow management isn’t just for covering expenses. It’s also essential for building reserves to fund expansions, navigate uncertainty, and mitigate risk.

In this guide, you’ll learn the top cash flow management strategies for small businesses, along with external funding options ideally suited to small and scaling businesses.

Essential cash flow management strategies for small businesses 

Achieving financial stability and healthy cash flow as an SME (Small to Medium Enterprise) will depend on how you manage and analyse inflows and outflows.

For CFOs, optimising cash flow isn’t just about financial stability. It’s a core catalyst for growth, building investor appeal, and long-term vitality.

There are a handful of approaches you can adopt to streamline and improve your cash flow management. 

Segment your cash

Segmenting your business’s cash reserves by use case ensures that you have sufficient funds for all scenarios. This can include:

• operational funds: Your day-to-day cash can be held in low-risk, instant-access savings accounts to prioritise liquidity and earn interest.
• reserve funds: Surplus capital allocated to high-interest savings accounts or term deposits can maximise returns for prospective growth opportunities.
• contingency funds: Separating some of your reserves into a notice account can cover unexpected costs or bridge cash flow deficits within a manageable time horizon, like 30 days. This lets you balance potentially higher interest earnings, while providing a buffer if you’re approaching the end of a challenging quarter.

Flagstone research suggests most SME users currently split their cash reserves almost evenly between fixed-term accounts (47%) and instant-access accounts (43%). This suggests many CFOs could be missing out on the balance of yield and liquidity that notice accounts can provide.

Opening and managing multiple, high-interest savings accounts used to be a manual process, creating a practicality barrier for time-poor CFOs. But cash management or savings platforms, like Flagstone, centralise your savings accounts into one dashboard, letting you split your reserves across a wide range of accounts that pay high interest.

This strategy can also significantly expand your Financial Services Compensation Scheme (FSCS) protection.

Make forecasting more agile and efficient

Efficient forecasting is essential for identifying cash shortfalls early and planning proactive measures to maintain financial stability. Modern software can let you stress test your finances, simulating risks like unexpected supplier dependencies and seasonal swings in demand.

Automated forecasting tools continuously update projections using rolling forecasts. They can automatically flag potential issues, giving you more time to act, and can identify unexpected surpluses, so you can re-allocate excess funds to higher-yield accounts.

CFOs might consider connecting accounting software like Xero or QuickBooks to a specialised cash flow management tool for small businesses, like Fluidly or Float, to gain control and visibility over finances.

Free up cash from your working capital cycle

Cash conversion cycles (CCC) - the time between investing in your products and making money from the sale - can make or break your cash position as a CFO.

But the latest research from JP Morgan suggests businesses are currently experiencing an average CCC increase of 2.3 days.

Delays between outflows and inflows can create cash gaps, with funds being tied up in various stages of the working capital cycle.

So, how can CFOs act to shorten or bridge these gaps? Viable strategies may include:

• reviewing payment terms: Compare payment terms for your Accounts Receivable to your Accounts Payable by tracking your Days Sales Outstanding (DSO) and Days Payable Outstanding (DPO). If feasible, you could explore negotiating shorter terms for customers or incentivising early payments with a discount when requesting extended terms with suppliers.
• inventory management: Review how long it takes to sell your inventory and calculate the amount needed to satisfy customer demand without tying up cash in excess stock for extended periods.
• credit control and invoicing: Use automated systems to increase efficiency in invoicing and sending reminders for overdue payments.

External financing for SMEs

External financing options can also be a useful way to fund short-term deficiencies without depleting company accounts. For example, you might consider raising external funds when financing excess inventory ahead of your peak season, or investing in growth opportunities where you anticipate a relatively quick return.

External financing can also act as a cost-saving tool, giving you the flexibility to advantage of initiatives like suppliers’ early-payment discounts, without tapping your reserves.

But it’s important to develop a clear repayment plan when borrowing. Poor debt management can result in strained cash flow and limited eligibility for future financing.

Business loans vs. line of credit for cash flow gaps 

Business loans and lines of credit are two widely used financing tools for SME cash management, each with distinct features to support different capital and cash flow needs.

The flexibility of a line of credit means it’s often a cost-effective option for managing fluctuations and evening out cash flow gaps. Once repaid, the cash becomes available again, providing ongoing access to working capital without having to reapply. You also only pay interest on the amount you use.

In contrast, traditional business loans charge interest on the full amount borrowed, making it more important to consider your requirements upfront. These are better suited to larger, fixed-cost investments like equipment, inventory, and property.

There are also specific types of business loans designed to support cash flow, such as working capital loans, which can cater to your company’s operational financing requirements.

Invoice finance

Invoice finance is a funding solution that gives businesses access to a percentage of outstanding payments upfront, using those invoices as collateral. This lets you cover immediate expenses to improve cash flow. You can typically get between 70% and 90% of the value of the unpaid invoice, depending on your circumstances.

There are two main types of invoice finance:

• Invoice factoring: The factoring company collects invoice payment directly from your customers.
• Invoice discounting: You retain responsibility for collecting the payment from your customers and repay the provider.

For small businesses with limited finance teams, invoice factoring can prove the more efficient option of the two. This is because the provider manages collections, freeing up your internal resources.

Merchant cash advances

A merchant cash advance (MCA) is a form of loan that is repaid through a fixed percentage of your future credit or debit card sales, rather than monthly instalments.

Since repayments fluctuate with the volume of your sales, you’ll pay less during slow periods and higher amounts when sales increase.

This flexibility can be beneficial when managing an unpredictable cash flow. MCAs are often used in sectors with consistent card-based revenue, like hospitality and retail.

But MCAs can be significantly more expensive than traditional business loans due to higher interest rates and fees. Unpredictable repayment rates can also make future cash flow more difficult to forecast.

Common cash flow mistakes made by small businesses 

Cash flow management challenges can vary widely across sectors.

Some industries, like construction, often benefit from stable and predictable cash cycles. Other industries, such as tech, face greater volatility due to rapid innovation and shifting market conditions, making it harder to forecast and manage cash flow.

Early missteps in small business cash flow management are commonplace for many companies. These can include:

• overestimating value, underestimating burn rate: Without a clear financial plan, funds can quickly deplete. 
• neglecting seasonality: Failing to prepare for fluctuations in customer demand.
• relying on a single source of funding: Exposing the company to risk if capital runs out.
• failing to build a robust cash reserve: Leaving the business vulnerable to unexpected expenses.
• under-investing in cash-positive operations: Missing growth opportunities to strengthen liquidity and returns.
• overlooking early forecasting patterns: Failing to detect upcoming shortfalls, delaying preventative action.

Frequently asked questions about cash flow for small businesses

What is good cash flow for a small business?

While every company’s financial situation is unique, it can be helpful for small businesses to maintain cash reserves that cover three to six months of expenses.

This would allow you to cover most unexpected costs without impacting liquidity and disrupting operations.

What percentage of small businesses struggle due to cash flow?

According to research from PYMNTS, 60% of small businesses cite ineffective cash flow management as their most overwhelming challenge.

Invest in cash flow management to drive growth and value

Robust cash management is one of the key strategic priorities for successful CFOs.

Combining strategy, structured reserves, and external funding creates an optimised cash flow model that can enhance your company’s growth prospects and position it as a viable investment opportunity.

Increase your cash yield with high-interest business accounts

Scale up your cash flow management with access to fixed-term, instant access, and notice accounts, with Flagstone.

Our platform gives you access to hundreds of accounts from over 40 banks – more than any other savings platform. 

All in one place, with one login.

Explore our business savings accounts