Effective cash flow management is what sets a successful business apart from the ones that are forced to close. Managing cash flow is not just about having enough money to cover financial expenses. It’s also about understanding how much money you need to generate to cover those expenses and then figuring out how to get it there on time.
Managing cash flow is not just about having enough money to cover financial expenses. It’s also about understanding how much money you need to generate to cover those expenses and then figuring out how to get it there on time.
A company's success hinges on its finance team's ability to understand and implement effective cash flow management strategies. This guide will cover some crucial strategies that help you manage your cash flow better.
In this guide, we will look at:
- What cash flow management is
- Why it’s important
- Effective cash flow management strategies
- And, finally: some expert-backed advice on best practices in cash flow management
By the time you reach the end, we hope to have left you with an in-depth understanding of all things cash flow management.
Cash flow management explained
Cash flow management is the process of managing cash transactions and the inflow and outflow of money to ensure that the business can maintain its liquidity. In addition, it guarantees that the business has sufficient funds to meet both its immediate and long-term financial obligations.
Cash flow management involves:
- Monitoring the cash on hand
- Keeping tabs on how much money is coming into a company versus how much is going out in the form of expenses like rent, utilities, and payroll.
- Taking proactive measures instead of a reactive approach through effective cash flow forecasting.
- Having sufficient cash reserves and healthy revenue streams.
Consequently, a company can manage risk better and make decisions on whether to borrow or not based on their financial health. It ensures that you have enough money to pay your bills and make a profit with a cash flow statement done correctly, giving you a full picture of your costs and revenues.
Cash flow statement
A cash flow statement is a financial statement that summarizes cash transactions over a specific period.
This will show the net change in cash and cash equivalents over a given period, usually one year. They do not include changes in the company's assets, liabilities, or equity accounts.
Using this statement will help a business owner understand if they have the following:
- A negative cash flow
- A positive cash flow
What does negative cash flow mean?
Negative cash flow is when your statement shows more money is leaving your business than coming in. The cash inflows are less than the cash outflow. It's a precarious position to be in as negative cash flow effectively means you're losing money.
What does positive cash flow mean?
On the other hand, positive cash flow is when the cash outflow is less than the inflow. You're getting more money coming in than is going out. It represents proper cash flow management and your business can boldly claim to have a healthy cash flow.
To learn more, head here for a handy primer on cash flow statements.
Why is cash flow management important?
If a company does not have enough cash or is cash flow vulnerable, it will not be able to purchase goods and services or meet payroll. Effective cash flow management is the only way a company can achieve this - and here are the benefits of doing so:
Meeting financial obligations in a timely manner
Get better at meeting your financial obligations promptly, including business expenses and debts. This is achieved through the systematic management of cash inflows and outflows to ensure that there is always enough money available to meet upcoming demands and accounts payable needs.
Providing a buffer against unprofitable periods
Receive a buffer against unprofitable periods in order to avoid bankruptcy or other serious consequences. The goal of cash flow management is to maintain a certain level of income from operations while avoiding excessively drawing down liquid assets. Specifically, it is the management of how funds are used at different points in time that ensures the company has enough cash on hand to meet its financial obligations in times of crisis.
Reducing the risk of a cash shortage and increasing profitability
Good cash flow management strategies can help you reduce the risk of a cash shortage and increase your profitability. By identifying expenses, sources of income, and understanding patterns of cash flow, you can make strategic decisions about how to spend your funds against incomes that fluctuate with sales volume.
Improving your credit score
Effective cash management can improve your company's credit score in the long run. When credit checks are undertaken to understand your financial position, having a good credit rating makes it easier for your business to borrow money from banks or other lenders when needed. If a company does not have adequate cash on hand to meet its financial needs, it could struggle to pay employees or suppliers at the end of the month. By improving their credit ratings, companies can get loans and also avoid defaulting on them.
How poor cash flow management hurts businesses
Navigating the cash flow management process is a major challenge for all companies. Large corporations with much more financial resources and access to capital can better handle cash flow problems when they arise. But SMEs don't have the same resources and can end up relying on methods like debt and equity financing that do not help them meet their long-term needs.
Whereas a larger business may have funds available as a stop-gap between late payments, smaller businesses rely more closely on their predicted monthly income to ensure their financial commitments are met. In serious cases, business owners can be left with no choice but to use personal funds to keep their businesses afloat.
Many SMEs make matters worse by trying too hard to secure their cash flow by doing things like borrowing funds, investing in high-risk ventures, and hedging their currency risk. These methods are risky and can lead to significant losses when they don't work out as planned.
In order to avoid compromising on financial resources in an effort to meet short-term operational needs such as meeting payroll or covering the cost of a large purchase, small and medium companies must use a variety of strategies that fill the gap between short-term and long-term needs.
Successful cash flow management strategies during a financial crunch
Cash flows depend on a range of different factors. A leak can form anywhere, and it can be challenging to pay the bills, let alone pay salaries and other operating expenses if money is not coming in regularly. This can be due to any one or a combination of the following factors:
- A change in customer purchase levels can lead to a domino effect of consequences.
- An over-reliance on one source of sales that has led to decreased customer purchase levels.
- Along with decreased customer purchase levels come changes in payment patterns that can lead to long payment timelines.
- Additionally, a lack of visibility into accounts receivable means that the company cannot identify where cash inflow issues are being caused
Below are some effective cash flow management strategies that can help you improve your cash inflow and accounts receivables management when times are tough.
Track your clients' payment patterns
Creditworthiness is an important aspect of the customer relationship. Checking your customers' creditworthiness can help you prevent future losses. Even if they are currently paying on time, their circumstances and payment habits can change. Running credit checks on new customers is a useful way to assess the risk of lending credit, and how likely you are to receive payment on time. Additionally, checking existing customers and monitoring credit scores on an ongoing basis will help you spot any red flags that may indicate your customers are likely to pay late.
Check if your credit policy is too generous
Credit policies that are too generous can allow customers to buy more than they can afford, which may lead to longer payment cycles. A realistic and achievable credit policy helps you avoid this. You should set clear payment terms and conditions, which you must follow as well.
Tighten up your accounts receivables management
Maintaining accurate customer and payment records, communicating with your customers regularly, and following up on late payments proactively can go a long way in ensuring that your business receives a reliable inflow of cash.
Review all costs and minimize them in times of recession and economic downturns
Tightening your credit control process and automating invoice reminders to receive payments faster are some of the ways a company can exercise better control over its cash flow management. This page talks about five proven ways to improve cash flow during a recession.
Find additional ways to generate cash
It is not uncommon for SMEs to try to juggle several different expenses while still trying to make ends meet. One way SMEs have found to manage their cash flow better is by finding additional ways to generate income.
Taking out a loan
As a business owner, you may be faced with the decision of whether to take out a loan or sell shares in your company. The decision will be based on many factors, including how much cash is needed, how much the company is worth, what types of loans need to be taken out, and more.
Selling assets
Selling assets is a type of financing strategy that can help companies build a sufficient and sustainable supply of cash. When it comes to obtaining the desired amount of money, this method has the potential to provide fast results.
Obtain new streams of financing
Be it a small or large company, funding is needed to grow and meet any existing or future needs. Obtaining financing through cash from financing activities would help provide the company with the necessary capital to help stay afloat. With this option of generating additional cash, you can also create a healthy buffer that can help you cushion the impact of slow sales or economic downturns.
Constantly monitor your cash flow
Cash flow is a measure of a company's financial health. It measures how well the company can pay its current and future bills. By monitoring cash flows regularly, you will have a complete view of how much money is coming in through sales, where it's going, and if you must adopt measures to keep expenses below your revenues and proceeds. You do this by monitoring the following:
Cash flow forecasts
Cash flow forecasting is vital for making better financial decisions about their business. With a successful cash flow forecast, you can make sure that your company has enough money to operate and grow as it needs to. You will see where the gaps are in your budget and make adjustments accordingly.
Cash flow statements
These detail the monetary inflow and outflow of a business. It provides an overview of how well you're managing your finances, as well as any potential opportunities for growth or improvement. The main components of a cash flow statement are:
- Operating cash flow
- Investing cash flow
- Financing cash flow
- Changes in cash position
Calculate your free cash flow
Free cash flow demonstrates the cash a company makes after accounting for operating cash flow, financing cash flow and investing cash flow. It tells you how much cash is left after you've dealt with your main expenses and operating costs.
Moreover, it enables you to generate positive cash flows by seeing what's causing a negative effect. Dealing with these things can help you pay expenses faster and avoid future cash flow issues.
The free cash flow formula is as follows:
- FCF = Operating Cash Flow - Capital Expenditures
By constantly keeping tabs on things, you not only understand its nature but also make more informed decisions about where to invest or cut back on expenses. This is one way to understand your present financial bottom line better.
Manage your inflows
The ultimate goal of cash flow management is to make inflows smoother and more predictable for effective cash flow management. The company must have enough cash on hand to maintain its operations and keep up with its debt obligations.
To accomplish this, you will have to:
- Send invoices to the customers quickly and receive payments just as quickly.
- Promptly follow up on late and overdue payments.
- Be flexible in your payments and give customers payment options.
- Increase your cash inflows by exploring different pricing options to find the most sustainable margin.
Manage your outflows
The other objective behind managing cash flow is to keep complete tabs on your cash outflows and ensure that you are bleeding money as little as possible. The key to running a successful business is knowing how to manage your operating expenses and liabilities, which is precisely what a cash management system will do.
- Make your outflows predictable and maintain smooth outflows by delaying expenditure until there is a stronger flow of cash.
- Another strategy is to negotiate with suppliers and customers to pay them in installments rather than in one lump sum, which will help reduce the number of times that your company needs to access your bank account or credit.
- Keeping your discretionary spending in check can help you save money, as can looking into bulk-buying discounts and other ways to cut costs.
Improving cash flow is a challenging task to tackle. Whether you're a small business or a large corporation, it's important to handle cash flow management with care. Improving this depends on balancing a variety of factors, but for most business owners, it's about improving the fundamentals.
What is some expert-backed advice for better cash flow management?
Determine your ideal cash balance
There are some things that you can do to improve your cash flow by following what the experts recommend. One of those things is determining what your ideal cash balance level is and finding out how long it takes for you to get there. Once you have that, you simply look for ways to improve your cash flows. This article contains 8 ways to improve your cash flow and makes a great starting point.
Control your debt ratio
Controlling the debt ratio is one of the five key cash flow management skills every entrepreneur must have. The debt ratio is a financial measurement of the proportion of debt to equity in a company's capital structure.
The debt ratio is a crucial accounts receivable KPI and is calculated by dividing total liabilities by total assets. This ratio measures how much money the company owes to creditors as opposed to how much it owes to shareholders. The debt ratio can be controlled in three ways: by raising equity, cutting costs, and accepting faster payments.
The debt ratio is an important metric for cash flow management because it determines the riskiness of the company's investments. The higher the ratio, the greater the potential for financial loss if there are any unexpected circumstances or events that can cause a decrease.
To be on the safe side, aim for a debt-to-equity or debt-to-assets ratio of less than 1.0; anything above 2.0 indicates potential for financial distress.
Take a proactive approach
Many companies operate with a reactive cash flow plan because they know there will inevitably be unforeseen expenses. But they eventually run into a dreadful cash squeeze.
For instance, your company may be having trouble paying for its regular operating expenses and only have a few week's worth of cash on hand. One option is to take out loans from banks or other lenders and pay the bills on a credit card. This might let you avoid bankruptcy, but it has certain downsides: your company must pay back more in interest than it would if it had planned for problems, and this debt would remain with the company for years. However, these interest payments can be offset by charging late payment fees to your customers on invoices that they fail to pay on time.
But when you take a proactive approach to cash flow management, such as monitoring your bills, purchases, and other expenses, you can identify your cash crunch before it happens. You'll be able to see any trends early on, and you might be able to avoid some of the debt and interest charges by taking a proactive approach.
Think of ways to finance your cash flow
If you're worried about coming up short on cash, financing may help you reduce your initial capital expenditure. Cash flow financing is a great way to give your business more leeway to respond quickly to opportunities, invest in novel products and services, and fill temporary funding gaps.
The two most popular means for getting cash flow finance are invoice financing and trade financing.
Invoice financing
Through the use of invoice financing, you can quickly improve your cash flow. The immediate payment of up to 85% of an invoice's value helps alleviate cash flow concerns. When your invoices are paid in full, the funder will pay you the remaining balance minus any applicable fees. Whilst invoice financing can be an effective quick fix for cash flow, fees must be paid to use the service and therefore sacrifice part of their revenue every time they opt for invoice financing. Luckily, there are many ways to receive timely invoice payments without paying a fee.
Trade financing
Trade finance is like leasing, where you get your initial capital upfront and make monthly payments, which are then applied to the purchase price. Companies that engage in international trade frequently turn to trade finance as an alternative source of liquidity funding.
Keep your cash flow forecasts updated
Your company's cash flow and working capital needs require a lot of calculating. There are six major components to determining your business's cash flow forecast, which are:
- Current assets (excluding inventory)
- Current liabilities
- Fixed assets (excluding inventory)
- Operating expenses
- Sales revenue
- Taxes
If your company is expanding, you need a reliable cash flow projection more than ever. So, always make sure you have an accurate picture of the company's cash flow forecasts and working capital needs.
Don't get bogged down in minutiae, but do make sure that the essentials of your company are covered.
Stay on top of your account receivables
Some companies are so focused on their sales that they forget to focus on their account receivables. This is not a problem if you have a good cash flow, but if your business is struggling with cash, then this could be the reason for your problems. The best way to avoid late payments and get invoices paid faster is to make sure that you follow up with customers after the sale and make sure they know how to pay. If your credit management is lax, you may have to fix it for faster payments. Here is a handy resource that details how to improve your credit management.
Be diligent about your financial reports
Financial reporting is the process of gathering financial data and presenting it in a way that's easy to understand. It's indispensable for all businesses to have accurate, up-to-date reports, so they can make decisions about how to grow their company.
- Monitor your cash flow statement (both inflow and outflow) because it reveals your short-term viability and aids in bill payment.
- Make sure your assets and liabilities are precise, specific, itemized, and balanced by keeping a close eye on your balance sheet.
- Keep an eye on your profit and loss account to make sure you're making a profit after a certain amount of time has passed.
- Have a clear overview of your debtors and the most crucial accounts to receive timely payments from
- If necessary, find out what you need to know to apply for money and investments, and incorporate a stock summary, asset register, and value-added tax account.
Harness the power of technology
Fintech tools have become indispensable for effective cash flow management. The key benefits of using fintech tools are cost-effectiveness, accuracy, and automation. They help make budgeting easier, show where to cut back on expenses, and much more. By automating invoices, scheduling reminders, streamlining invoice generation, and automatically managing payroll and taxes, these tools help improve cash flow and efficiency.
Good credit management leads to healthy customer relationships
Credit management is a complex process that needs to be tailored to the individual needs of each customer. There are many factors that can play into how an individual handles their credit, and this needs to be taken into consideration when setting up a credit management strategy.
By looking at payment patterns and customer preferences in the aggregate, you can predict customer behaviours, and, consequently, their payment behaviours. If you want to understand customers better, consider implementing customer segmentation to improve your payment times from different customer groups, and improve your cash flow.
Not sure where to start?
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