Credit: Jacques Nel (MBA, MSc)
Good cash flow management can mean the difference between business survival and business failure. This guide looks at the key elements of cash flow management and will help protect the financial security of your business. It outlines the steps that you can take when dealing with your customers, suppliers and stakeholders to improve cash flow. It also highlights common cash flow problems and how to avoid them.
Cash versus profit
Profit is the difference between the total amount your business earns and all of its costs, over a given trading period. Cash flow (inflows and outflows) is the movement of cash into and out of your bank account. Good profits do not necessarily mean your business is healthy. Bad cash flow management can leave you cash strapped and fighting for survival.
To trade effectively and be able to grow your business, you need to build up cash reserves by ensuring that the timing of cash movements puts you in an overall positive cash flow situation (inflows exceeding outflows). Income and expenditure cash flows rarely occur together (inflows often lag behind). You must aim must to speed up the inflows and slow down the outflows.
To improve everyday cash flow you can:
- ask your customers to pay sooner;
- chase debts promptly and firmly;
- use factoring (obtain 3rd party advance on portion of invoice);
- ask for extended credit terms with suppliers;
- order less stock but more often;
- lease rather than buy equipment;
- improve profitability;
- increasing borrowing (not to be used as long-term strategy);
- putting more money into the business (not to be used as long-term strategy);
- set up cash flow management systems (who are responsible for tracking cash flow? How regular should forecast be reviewed?);
- arrange special terms with suppliers (30 day accounts, billed quarterly, etc.);
- control cash outflows (switching suppliers if necessary, negotiating once-off purchases);
- get accounting software to track cash flow and make forecasts;
- use forecast to spot problems;
- bank money the instant it comes in;
- shop around for better deals that could reduce costs;
- monitor the effectiveness of your marketing and modify it as necessary (cash inflows).
Cash flow problems and how to avoid them
No matter how effective your negotiations with customers and suppliers, poor business practices can put your cash flow at risk. Look out for:
- Poor credit controls – failure to run credit checks on your customers is a high-risk strategy, especially if your debt collection is inefficient
- Failure to fulfil your order – if you don’t deliver on time or to specification you won’t get paid. Implement systems to measure production efficiency and the quantity and quality of stock you hold and produce
- Ineffective marketing – if your sales are stagnating or falling, revisit your marketing plan.
- Inefficient ordering service – make it easy for your customers to do business with you. Use first class post and, where possible, accept orders over the telephone or Internet. Ensure catalogues and order forms are clear and easy to use.
- Poor management accounting – keep an eye on key accounting ratios that will alert you to an impending cash flow crisis or prevent you from taking orders you can’t handle.
- Inadequate supplier management – your suppliers may be overcharging, or taking too long to deliver. Create a supplier management system
- Poor control of gross profits or overhead costs.
Cash flow forecasting
Cash flow forecasting is essential in managing your business’s cash flow effectively. It helps predict peaks and troughs in your cash balance, plan borrowing and predicts surpluses at a given time. Having a regular review of your cash flow forecast will enable you to:
- see when problems are likely to occur and provide solutions in advance;
- identify any potential cash shortfalls and take appropriate action;
- ensure you have sufficient cash flow before you take on any major financial commitment.
The forecast is usually done for a year or quarter in advance (projected monthly or weekly). The forecast lists:
- receipts (inflows – sales etc.);
- payments (outflows – expenses etc.);
- excess of receipts over payments – with negative figures shown in brackets;
- opening bank balance;
- closing bank balance.
Established businesses can combine historic sales (previous 12 months) with predicted growth to compile realistic forecast estimates. Forecast figures are based on sums that are due to be collected and paid out, and not on invoices actually sent and received. Adjust forecasts in line with long-term changes to actual performance or market trends, in light of your sales, purchases, staff costs and changes in legislation, interest rates and tax rates.
Finally, have a contingency plan, such as retaining a minimum amount of cash in the business in an interest-earning account, to meet short-term cash shortages.
To assist you in effectively managing your business’s cash flow invest in accounting software that makes planning and cash flow forecasting easy or contact a professional for assistance.