Standard accounting software packages can help businesses foresee bottlenecks and timing issues, and gives enough time to take action to resolve these difficulties.
Great cash flow management, however, is more than running an accounting software package. The following steps can help any business ensure it is managing cash flow effectively.
Benefits of cash flow management
If you're wondering what you can do to keep your business ticking along without borrowing money (or even worse running out altogether) then look no further than good cash flow management.
Cash flow is the lifeblood of startups and small enterprises and it's easy to see why. Cash is what allows your business to survive. Without adequate money coming through the door, you won’t be able to cover your monthly expenses or even consider expanding your business.
As Clive Lewis, head of enterprise at the Institute of Chartered Accountants in England and Wales, says, “there is an old maxim that no business ever collapsed because of lack of profitability but many have gone under because they lacked cash. Managing your cash resources and making sure you have enough to meet your needs, such as paying wages, buying supplies and meeting your personal financial requirements, is absolutely critical.”
But good cash flow management isn’t just about having a constant stream of money coming in. It also enables you to future-proof your business. Here are some other benefits of good cash flow management.
YOU WON’T RUN OUT OF CASH
No doubt this is the biggest advantage of good cash flow management. Managing your cash flow well, will let you predict how much money you’ll be bringing into your business and ensure that it's always more than you'll need to spend.
YOU CAN PAY YOUR STAFF ON TIME
Your employees are the "frontliners", who help you keep your business running and more often than not good staff are hard to find. Therefore, paying your staff on time is not only the right thing to do, it also makes good business sense.
With good cash flow management, you’ll never have to worry about whether you can pay your staff on time as you will be able to regularly set aside cash for their renumeration.
YOU CAN PURCHASE ALL THE RAW INGREDIENTS YOU NEED TO FULFILL YOUR ORDERS
Need baking flour to complete that pastry order? Or flavourings to add to your cold beverages? Managing your cash flow properly allows you to have a clear projection of your account payables. So you'll be able to purchase the ingredients you need when you need them. And when you find yourself consistently maintaining a positive cash flow you can even start thinking about expanding your product line. Awesome!
YOU’LL HAVE PEACE OF MIND
There’s nothing more stressful than running out of money. Fortunately, with good cash flow management, you'll worry less about making ends meet because you'll have enough money in the bank to meet all your obligations.
Increased stress levels aren’t good for a busy entrepreneur like yourself. Not only can it affect the way you run your business but it can also have a detrimental effect on your staff and customers. Being in a positive cash flow position means you'll be able to run your business more effectively and concentrate on more of the fun stuff.
YOU CAN AVOID OVERSPENDING
If you don’t have a good cash flow management plan in place, you will find yourself guessing how much money you need to spend for each payable. This usually results in overspending or worse - using cash you have reserved for something else.
Managing your cash flow effectively, will give you greater control over your cash. Your spending will be contained and you can guarantee you will have enough cash reserves to use in case of unexpected expenses.
YOU CAN GROW YOUR BUSINESS
For most startup and small business owners, there is only one thing they want to see: their business thriving. An effective cash flow management plan will prevent you from running out of money so you can always say yes to growth opportunities.
Effectively managing your cash flow is the key to your business’s success. By implementing a smart cash flow management strategy you will be able to address any shortfalls immediately, set up your business for future growth and have peace of mind that you will always be able to pay your bills on time.
Not sure how to manage your cash flow properly and ensure you have a positive financial position? Here are some quick tips we’ve put together just for you:
1. Perform a regular cash flow forecast - estimate how much profit you’ll be bringing in and how much money you will spend.
2. Save the cash you have on hand. Before purchasing anything, always ask yourself first: do I really need it?
3. Maintain cash reserves to cover unexpected expenses or shortfalls.
4. Improve your account receivables by making sure your customers pay you on time.
5. Automate your invoicing to prevent delayed payments.
6. Boost your sales to guarantee you always have more money coming in than going out.
7. Keep the money coming in by offering different payment methods.
8. Always pay close attention to your daily ordering activities. That will give you essential information that could help you predict future sales.
9. Consider offering shorter payment terms.
10. Leverage technology or the online tools that can help you get on top of your cash flow. For example, an accounting software, an inventory system, or an order management app.
Business cash flow risk management strategies
A river of money flows in and out of your business every day, and if you’re not managing it effectively, you might find your coffers running dry when it’s time to pay bills, cover surprise expenses, or direct capital into innovation and growth. Cash flow risk is the term used to describe the potential danger of falling short created by your cash flow management practices—the lower your cash flow risk, the better equipped your company will be to use its working capital effectively.
Taking control of your cash flow risk can seem daunting. But by implementing the right best practices, you can optimize your cash flow risk management and rest easy knowing you have the funds you need, when you need them most.
Understanding Cash Flow—and Cash Flow Risk
While it may be confused or conflated with profits by some, cash flow is actually a process, not just a figure on the balance sheet. Cash flow can be positive (more cash is flowing in than out) or negative (more cash is flowing out than in). Negative cash flow presents a much higher financial risk for businesses of all sizes and types, especially since it’s possible for a company to have a negative cash flow while still generating a profit.
That’s why cash flow has its own financial documentation (the cash flow statement) to record all cash flowing in and out of an organization through its financing activities, operations, and investments. The profit and loss statement (also called the income statement), on the other hand, records expenses, total sales, and profits. The two are indeed connected, but profits are not the same as cash; rather, a net loss on the income statement increases cash flow risk, since capital will be diverted to cover the gap between sales and operating costs.
Investors and lenders regard long-term positive cash flow as an indicator of value generation, creditworthiness, and stability. Consequently, managing cost flow risk is crucial to both the immediate financial health and long-term growth of your company.
Without careful, consistent, and complete cash flow risk management, a company could find itself teetering on the brink of disaster due to a lack of readily available funds.
Effective Cash Flow Risk Management Matters
A lack of readily available capital can make or break a business—particularly during tough times, such as a recession or a pandemic like the COVID-19 crisis. Cash is used to cover not just short-term debts like vendor invoices and operating costs, but interest payments on long-term financing. Without careful, consistent, and complete cash flow risk management, a company could find itself teetering on the brink of disaster due to a lack of readily available funds.
To understand cash flow risk, it’s important to know a few key terms:
- Cash Flow at Risk (CFaR) is a measure of how changes in market variables can cause future cash flows to fall short of expectations, as well as the extent of those changes by risk factor.
- Value At Risk (VaR): Similar to CFAR. A metric used to measure an investment’s potential loss over a specific time period, generally expressed as the probability of loss exceeding a specific threshold (e.g., $3 million over a given year).
- Liquidity Risk: A measure of how well an organization can cover its short-term financial obligations. Liquidity risk increases when a company lacks the working capital to cover these costs, or has sufficient assets, but cannot readily access them in a timely fashion or without significant financial loss.
A comprehensive cash flow risk management strategy accounts for the many different scenarios in business-critical areas that can affect, and are affected by, cash flow, including:
- Operational Strategy: The standards and practices set for accounts receivable, procurement, and accounts payable will have a pronounced impact on how cash enters and exits a business, and a direct impact on a company’s liquidity risk.
- Market Conditions: The availability of corporate finance options (and the relative ease of corporate financial management) are directly tied to market risk. Small businesses, already hobbled by fewer capital market investment and lending options than their larger brethren, may find themselves struggling to find investments they can readily liquidate to improve cash flow, or long-term investments that provide equity for debt management. This is especially true during a crisis or market downturn/recession. Market conditions have a strong impact on both CFAR and VAR for both your business and your evaluation of other organizations in which you may choose to invest.
- Industry-Specific Risks: A sharp downturn in any industry, whether due to economic disruption, abrupt changes to commodity prices, a loss of customers, etc., can raise expenses and reduce sales, slashing operational cash flows.
- Investment Strategy: While major investments are generally long-term, rather than short-term, expenses, they can absolutely affect cash flow. Interest payments (and their associated interest rates) can consume a sizable chunk of available cash during a given period, depending on your company’s investment strategy. In addition, pouring large amounts of capital into expensive equipment or real estate can raise cash flow at risk by reducing liquidity for the immediate and near future.
- Balancing Short- and Long-Term Debt: Striking the right balance between debt and equity is crucial to keeping cash flow risk to a minimum. Too many short-term debts can create a crisis if they’re called in when cash is low, while long term investments may not be as readily available for small businesses.
Improving Your Cash Flow Risk Management
In tackling a complex process like cash flow management to improve performance, reduce overall risk as well as cash flow at risk and value at risk, and effectively track (and manage) debt capacity, you need a clear plan and the right tools.
Consider making these best practices part of your cash flow risk management strategy:
1. Invest in Automation and AI
Reducing all your financial risks, including cash flow risk, begins with total transparency into, and control over, your company’s financial activity. A comprehensive solution like PLANERGY gives you access to tools you can use to:
- Perform smart and strategic risk assessment.
- Monitor and optimize your entire procure-to-pay (P2P) process
- Leverage on-demand visibility of all your company’s cash flows (both in and out)
- Integrate your P2P workflows with other accounting software to ensure you have accurate and complete information you need to manage cash flow and reduce risk.
In addition, by centralizing your data management, strengthening your reporting and forecasting capabilities, and incorporating process optimization (including key performance enhancers such as automatic three-way matching of vendor invoices), you’ll be able to implement all the other best practices for cash flow risk management more effectively.
2. Optimize Your Cash Inflow
In good times and bad (but especially in bad), making the most of every incoming dollar is crucial to business continuity and growth. You can gain better visibility into, and control over, incoming cash flows by:
- Offering your customers a variety of payment options. More options increase the likelihood of faster payment.
- Promptly issuing and following up on invoices.
- Providing clear incentives for early payment (including the occasional early payment discount where prudent) and firm consequences (including fees) for late payments.
- Increase your customer base by:
- Developing new goods or services.
- Getting creative with your marketing to reach new markets.
- Developing and implementing a referral program to grow business and reward loyal customers.
- Performing additional cost and market research to determine whether you can, and should, be charging higher prices for goods and services.
- Selling your unpaid invoices in order to generate cash immediately (i.e., invoice factoring). The purchaser takes a small fee off the top and then collects the payment from the original customer.
- Strategically leveraging small business loans to fund expansions, purchase new equipment, cover unexpected costs (or mitigate seasonal shortages), and invest in research and development.
3. Optimize Your Outgoing Cash Flows
Chances are, your management team wants the biggest possible return on investment (ROI) for every dollar you spend, along with healthy levels of liquidity, VAR and CFAR. You can make it happen by:
- Reviewing and eliminating any unnecessary expenses.
- Making strategic upgrades to equipment and technology. The immediate costs will be readily offset by long-term value in the form of greater production capacity and efficiency, as well as lower maintenance and labor costs that free up more cash.
- Optimizing your workflows to reduce cycle times for both purchase orders and invoices.
- Using a comprehensive P2P solution can make this much easier, and provide a foundation for a larger digital transformation and business process optimization
- Automation and data management create a closed buying environment that lowers costs and increases value by eliminating rogue spend and invoice fraud.
- Capturing more discounts from vendors through early payments.
- Taking strategic advantage of extended payment terms when you need more cash.
- Negotiating the best possible payment terms with vendors through contract negotiation and supplier relationship management (strategic partnerships, e.g.).
- Transferring some short-term debt to long-term debt through financing or the use of corporate credit cards.
Keep Your Cash Flowing and Your Business Thriving
Is your company’s cash flow a healthy torrent you can tap on demand, or an unpredictable deluge that suddenly becomes a trickle when you need it most? Invest in the tools and techniques you need for effective cash risk management, and you’ll have a firm grasp on your company’s working capital, visibility into and control over cash payments, and stronger resistance to cash flow volatility that can hurt not only your operational agility, but your credit rating and perceived value generation for investors and lenders.
Best practice in cash flow management
According to Craig West, CEO of business strategy firm Succession Plus, most businesses don't forecast cash flow. "They may have experienced an extended time when cash flow has not been a problem so they drop the discipline of projecting cash," he says. "Then something happens – for example a financial shock or a client goes bad - and suddenly cash flow is a problem."
It is relatively easy to predict cash outflows, as companies know when they have regular payments such as tax, salaries and operational costs. Inflows are much less certain, as it's difficult to know exactly when customers are going to pay. "Overdue payments are the biggest risk to small and medium business cash flow," says Ennio Alberici, Finance Director for Sage Software Australia.
Craig West suggests some practices for managing late payments. “Have an automated system in place that follows up late payments, do credit checks on all new clients no matter how good they look, and establish a relationship with a bank that understands your business model and your cash flows," he says.
Good technology and systems are key to improving and managing cash flow. This includes receiving timely information from an integrated digital banking platform. “Best practice for billing means using cloud-based software and electronic payment solutions, which provide invoicing tools that save time and optimise cash flow," says Alberici. "They allow you to offer multiple forms of payment and quickly follow up with clients by giving business owners easy access to invoice records and reports."
Planning around larger cash inflows and streamlining invoicing processes also help to smooth cash flows and prevent bottlenecks and shortfalls.
Best practice for running a cash flow forecast
Running a cash flow forecast doesn't have to be complex or time-consuming. A cash flow forecast can be mapped out in just 30 minutes, says Kerry Dutton, Founder of online bookkeeping business Think180degrees.
"It's easy to start looking in the wrong places, such as manuals, external data analysis and complicated templates. The main purpose of your cash flow forecast is to provide a forward thinking perspective you can use to plan ahead," she says. “Use a cash flow forecast to aim the business towards success and give the business owner clarity, financial focus and balance."
Here are Dutton's three steps for implementing best practice cash flow forecasting:
1. Just begin
Start, as something is better than nothing. Begin with what you know and review the forecast at least every six to 12 months.
2. Use good business data
Industry data and competitive analysis is often backward looking and of little use when it comes to cash flow forecasting.
It may be appropriate to use historical assumptions where these are relevant to predict a likely future outcome. For example, the most reliable source of historical evidence in a business is key performance metrics, such as average client conversion rates and growth rate of new clients per month.
3. Apply 'what if' scenarios
The basis of cash flow forecasting is to model alternative scenarios that could take place during the forecast timeframe. It is tempting to pick the rosiest scenario and hope that this will eventuate. But a more realistic approach would evaluate less beneficial scenarios too, thus helping the business foresee and develop strategies for managing "worst case" cash flow problems. It is also important to question growth assumptions, and consider what would happen if certain services didn't perform as expected.
For example, suppose you forecast your business to grow from $300,000 to $1 million, but a huge proportion of this is reliant on the success of a first online program. If that program falls short of expectations, the forecast will be wrong. Launching an online program for the first time is a risky business, since there is typically little historical evidence on which to rely. So a prudent forecast might apply a discount factor to the ideal outcome to recognise the risk that sales might disappoint or the program develop problems.
Great cash flow management isn't a quick fix. It needs discipline and attention to detail. Cash flow needs to be reviewed at least monthly to help the business move through any money limitations.
Key Takeaways
- Don't undercharge upfront: revalue products by breaking down all the included value and the time spent on each component.
- Love the numbers: create a monthly cash flow plan and set three goals to improve cash flow in 90 days.
- Overcome limitations: ensure business processes are appropriate. For example, don't provide a service prior to a deposit payment.