The key to running a thriving business lies in maintaining strong cash flows. And yet, small businesses following healthy cash flow management practices is a rare occurrence, as substantiated by over 90% of SMEs experiencing at least one cash crunch per year.
So, what are cash flows, and what is the best way to manage them? We elaborate below.
What is cash flow in business? | Cash inflows and outflows
Cash flow represents the event of cash coming in and going out of your business. In other words, it is the difference between cash inflows, such as revenue from sales, and cash outflows, represented by salaries, wages, rents, and other expenses.
A positive cash flow is indicative of the company’s ability to adequately meet its daily expenses and reinvestment needs without causing undue pressure on its liquidity position.
Read more about positive cash flow in this article: How does your business become cash flow positive?
What is the best way to monitor cash flow?
Companies can keep track of their cash flows by creating a cash flow statement (CFS). In this statement, cash flows are subclassified into three categories:
- Cash flow from operating activities: It accounts for the cash brought into the company through regular business activities, namely production and sale of products, provision of services, etc.
- Cash flow from investing activities: It represents the cash flows related to investment activities, including the purchase and sale of fixed assets and investments in securities.
- Cash flow from financing activities: It states the net cash used for the company’s funding activities, such as the issue of equity and debt, dividend payouts, etc.
See also: Cash flow statement: what you need to know
How can a small business manage its cash flow?
A company generating negative cash flow faces severe liquidity issues, such as difficulties in paying off debt payments and meeting payroll, rent, and other operational expenses. An Intuit study estimates that one-third of small businesses cannot make their interest payments due to cash flow problems. The lack of cash on hand also limits the capital expenditure plans that firms can pursue to sustain future growth and create new products.
Given this scenario, it becomes imperative for business people to manage their cash flows well to be able to operate efficiently and maintain the requisite financial health.
So, how do you manage cash flow effectively?
1. Create cash flow forecasts
Cash flow forecasting serves as an effective early warning system for cash crunches. You should draw a cash flow budget based on historical cash flow trends, accounting for big-ticket purchases, slow sales seasons, and contingency expenses.
Pay heed to business risks such as business order cancellations, stalling of payments, and the slowing down of the economy as a whole. This can be done by conducting scenario analysis using an Excel template or accounting software.
2. Make cash flow statements
Staying on top of your financial reporting is essential for tracking the cash position of your business. Cash flow projections should be followed up with the generation of cash flow statements that reveal the actual amount of cash generated and spent in the financial year. Such a statement can be created through two methods: direct and indirect.
While the direct method directly accounts for the difference between cash receipts and cash payments, the indirect method modifies the net income to calculate the final cash on hand balance. The indirect method is more popular as it is based on the accrual method of accounting and keeps track of cash generated from operating activities, financing activities, and investing activities.
3. Analyse variances
The primary purpose behind creating a cash flow forecast is to compare your projections with actual performance. In cases of material divergences, firms can analyse whether the variance is due to poor projections that may require further tweaking or because the company follows poor cash management practices.
In the latter case, the firm can take corrective measures to improve its cash inflows by speeding up accounts receivable, cutting down on expenses, or even taking on a loan before things get out of hand.
It is a good practice to monitor your cash balances on a weekly or monthly basis to ensure there are no material variances between actual cash flows and forecasts.
How to improve the company’s cash flow? UK statistics
According to research, almost 23% of UK small businesses experience negative cash flows that last over six months. Indeed, SMEs remain cash-negative for nearly 4.5 months on average in the UK.
As cash flow changes severely limit business decision-making and impede the undertaking of growth investments, companies must take the necessary steps to improve their cash inflows. Below, we discuss some of the best ways to improve your cash flow.
1. Maintain a separate bank account
It isn’t unusual for small business owners to bootstrap their setups. The problem arises when there is no separation between personal and business expenses. So, the first step for ensuring better cash flow management is to create a separate bank account for your business.
This will help you keep track of your expenses and avail of any overdraft facilities when necessary. Banks usually provide special services for their business customers. Go a step further by getting a business credit card issued and making use of the monthly management reports for effective purchase management.
2. Expedite late supplier payments
A study found that SMEs, on average, receive their payments after a delay of 5.8 days, which can cost them upwards of £684 million annually. In some instances, over 12% of the invoices are paid after a month’s delay.
So, the best way to manage cash flow in such cases is to send out invoices and reminders to the clients quickly. Have an option for vendors to make payments electronically and penalise slow payers by charging interest. This change in payment policy is likely to allow you to access your money more quickly and avoid cash shortfalls.
Related article: Payment reminder: How to write one to a client
3. Increase your revenue
The easiest way to raise your revenue is to drive more sales. It can be done through several methods, including attracting more customers by marketing on various platforms or raising prices, provided they remain competitive by industry standards. You can also pursue upselling opportunities to raise the average order value.
4. Lease or finance assets in place of downright purchases
Unless you are exceptionally flush in terms of cash flows, it makes sense to finance any long-term asset purchases. This will stagger your cash outflows in terms of instalments.
Alternatively, you can even lease an asset. Such decisions can be made by comparing the present value of lease payments and instalments. This will allow you not to spend much money at once and keep your balance stable.
5. Create a cash buffer
A healthy cash flow management practice is to create a contingency fund that holds an amount equivalent to at least three to six months of working capital expenses. Such a fund comes in handy in times of emergencies and economic distress (cue: COVID-19). Cash reserves can be maintained in the form of cash, an overdraft, or a revolving credit facility.
6. Eliminate unnecessary expenses
Another good way to manage your cash flows effectively is to prune excessive spending. For instance, if your marketing strategy isn’t effective in driving more sales, then cut down on the marketing budget and redesign your strategy. Similarly, you can save on costs by outsourcing non-core functions or automating operations, saving on employee costs.
7. Invest and grow your cash
One way to keep cash flowing is to invest cash in interest-bearing accounts after accounting for daily expenses and cash buffers. Money market accounts, certificates of deposit (CDs), and savings accounts are great alternatives.
However, it’s best not to invest long-term in funds with lock-in periods, as pre-payment penalties can be hefty.
What are the 5 cash management tools to reach your objectives?
Cash flows can be streamlined by utilising cash management tools that further financial success. The top 5 cash management tools are as follows:
Financial planning: It entails the formation of strategic plans, identification of sources and uses of funds, and development of realistic budgets. Companies can also plan for taxes when working out their cash outflows. Planning for the short and long term puts you in a stronger position as it allows you to always remember the important things and concentrate on the goals you want to achieve.
Budgetary control: A budget outlines expectations of business earnings and spending over a specified period. By drawing cash budgets, project budgets, and operating budgets, small businesses can keep on top of their goals and take remedial actions in case of major discrepancies.
Expense management: This tool aids companies in tracking expenses claimed by employees, such as travel and entertainment expenditures. An expense management software ensures businesses don’t end up overspending while hastening claim validation and reimbursements.
Payroll management: It assists firms in managing and automating employee salaries, and maintaining a financial record of gross earnings and deductions. Business people can evaluate these records to determine if they are getting the biggest bang for their buck and whether any cost savings can be made by outsourcing or hiring on contract.
Inventory management: Companies can gain real-time inventory visibility by automating inventory management. This helps keep inventory levels lean as firms can ascertain which goods are hot-selling and which goods have been blocking capital. By disposing of unproductive inventory and buying only the amount of raw materials they need, firms can rationalise their cash flows.
Improving cash flow: Key takeaways
Poor cash flow can significantly reduce the growth opportunities for your business. Not having enough cash at a certain point can leave you unable to cover the needs of your business and create unnecessary expenses due to late payments.
In addition to the efficacy of a business plan, long-term financial success is also a factor of good cash flow management. The best way to manage cash flow while spending less time on accounting is to use cash flow management software and tools that automate expense tracking, mark out unproductive inventory, and invoice vendors timely.
Agicap is the perfect tool to anticipate payment difficulties!
Test it for free 🚀