“Never take your eyes off the cash flow because it’s the lifeblood of business.” – Richard Branson.
Cash flow management is an integral part of running a successful business. It’s a practice that is meant for not only large corporations but also small business owners to benefit greatly from an efficient cash flow plan.
An “Intuit QB Cashflow III Survey” showed that 82% of small businesses frequently struggle to maintain a healthy cash flow. Furthermore, 40% say their business growth was limited because of this cash crunch. Considering the importance of cash flow, many business owners misunderstand how it contributes to business health and continuity.
Real estate developers are especially vulnerable to cash flow problems, requiring substantial capital investment and ongoing expenses for their operations. Business owners that plan rapid expansions or invest heavily in inventory also find themselves without enough incoming cash to cover their debts and outgoing payments.
On the other hand, some businesses may need help to collect pending payments from their customers for goods and services delivered. These situations can be handled better by managing the cash flow.
This article will help you understand the cash management process and provide strategies to help you maintain a healthy cash flow.
What is Cash Flow Management?
Cash flow management involves planning, tracking, and controlling cash movement in and out of your business. A regular cash flow analysis should be part of your routine as a business owner. This helps you prevent and tackle cash flow problems before they threaten to overwhelm your business.
With a cash management plan, you can:
- Forecast the company’s future cash needs
- Ensure that the business has enough funds to cover its expenses
- Manage and invest extra cash or resources more effectively
- Help the business stay financially stable
There are several categories of cash flow and different ways to calculate each. However, the simplest way to determine a positive or negative cash flow is to count the incoming payments against the outgoing expenses. While larger companies may need teams and accounting software to calculate these figures, small businesses can start keeping track of their cash flows on a simple spreadsheet!
Categories of Cash Flow
Even in small businesses and startups, cash flows through many parts of the organization. Therefore, it is essential to understand the different categories of cash flow and how to calculate cash flow at different stages of the business cycle.
1. Cash Flows from Operations (CFO)
This money comes in from day-to-day operations in a business, like the production and sale of goods or service deliveries. A healthy CFO means your business has the funds to pay its bills and handle operating expenses. However, cash inflows should exceed outflows.
Operating cash flow is determined by adding your net income and non-cash expenses. You can then subtract the change in working capital.
CFO = Net Income + Non-Cash Expenses – Change in Working Capital
2. Cash Flows from Investing (CFI)
This figure represents how much cash has been generated or spent from the company’s investments. It calculates the amount received after adding the buying or selling of property, equipment, or other business assets.
| CFI = | Purchase | +Purchase+PurchaseSale of Marketable SecuritiesSale of Other Businesses |
| Sale of Property and Equipment |
3. Cash Flows from Financing (CFF)
The cash flow from financing activities (CFF) is the company’s total cash flow from its owners, creditors, and investors. In other words, it reflects the mix of financing the company uses.
To calculate cash flow from financing activities, you need to add dividends paid to repurchases of debt and equity and subtract the total from cash inflows from equity or debt issuances.
CFF = Cash Inflows from Issuing Equity or Debt – (Dividends Paid + Repurchase of Debt and Equity)
4. Free Cash Flow
‘Free cash’ is the amount left after your company has fulfilled all its obligations to investors, employees, and customers. Calculating this amount gives you a better idea of future spending. In addition, it tells you how much cash your business has at its disposal.
Free Cash Flow = Net Income + Non-Cash Expenses – Change in Working Capital – Capital Expenditure
The Importance of Cash Flow in a Small Business
A small business’s cash flow is crucial because it reveals how much money is moving in and out of the company.
With an increase in cash flow, you can rest assured knowing that you are earning more than you spend. This means you’ll have cash on hand to handle the following:
- Employee salaries
- Equipment purchases
- Loans or mortgages
- An upgrade in operations
- A stable working capital
- Production costs
- Marketing expenses
- Payments for suppliers and inventory.
By calculating the cash flow of your small business, you can
- Get accustomed to the revenue cycles of customers, vendors, suppliers, and contractors.
- Predict the cash flow accurately with time.
- Steer your company in the right direction with timely investments and growth strategies.
- Get ahead of the competition.
- Safeguard your company against unexpected bumps in the road.
Small business cash flow management can bring many new opportunities when done correctly at the right time. It is one of the most critical steps in financial planning for small businesses.
5 Cash Flow Management Strategies
Here are a few cash flow management strategies to help you streamline and maximize your incoming cash flow while making provisions for your outgoing expenses:
1. Forecast Expenses in Advance
They say you can see the future clearly if you look back and study the past. The same holds in business! Based on your company’s past performance, you can effectively estimate the cash expected to come in and go out, leading to an accurate cash flow projection.
Why is Managing Cash Flow So Important
Cash flow projections help:
- Alleviate stress during slow periods in the business cycle
- Identify potential causes for a cash crunch
- Identify your break-even point; the amount of money you need to cover your fixed and variable expenses during a given period.
- Plan for times when you might be low on cash
- Fulfill your obligations to investors, employees, and customers.
- Allocate surplus cash toward an emergency fund or new investment opportunities.
2. Regulate the Invoicing Process
Recent data shows that just 29.1% of invoices are paid on time in America. Outstanding payments can significantly cripple your business operations. Regulating your invoice process can be a great way to ensure you can get your accounts receivable on time.
Here are a few tips that may help:
- Charge in Advance: Collect deposits upfront before you begin the sale or the service, whenever possible.
- Add payment terms and conditions to your invoices with a “NET 30” schedule. Your customers must pay their bills within 30 days of the invoice.
- Offer discounts to customers who clear invoices and make deposits on time.
- Add penalties for late payments.
- Follow up with customers with outstanding invoices.
- Instead of mailing invoices, set up e-invoicing for a faster, automated process.
- Integrate various payment options like credit cards, mobile payments, and electronic payments like Electronic Funds Transfers (EFT).
3. Consider Invoice Factoring
Invoice factoring has become a popular way to secure your cash flow. Factoring companies buy your outstanding invoices, paying you 80-90% of the amount due on the invoice. They take on the onus of tracking down your customers for their payments. Once the entire invoice is clear, they pay you the remaining amount.
The advantages of invoice factoring are:
- Business owners do not need to offer up collateral to avail of this option.
- Small businesses get the breathing room they need to keep their operations running, even when cash flows are low.
- Entrepreneurs have access to a more affordable financing option than standard bank loans with high-interest rates.
4. Take Steps to Prevent Fraud
In the US, companies lose around $300,000 per business annually to fraud. Allow only essential employees to access the company’s financial data to prevent external hacks or internal leaks. Set up a system for checks and balances for each process so that all the employees are accountable to each other. This is especially crucial in areas like accounting and bookkeeping, overtime, and expense claims.
5. Improve Inventory Management
Surprisingly, 43% of small businesses either use an outdated manual process to track their inventory or don’t do so at all. Keeping your inventory under control allows you to manage your cash flow better.
Good inventory practices achieve the following:
- Maximize intermediate and raw materials
- Reduce wastage and loss of materials
- Avoid wasting resources on material that is not needed
- Find an effective way to check for and discard expired materials
- Ensure adequate stock of all supplies, preventing back-orders, stock-outs, and customer complaints
- Optimize employee working hours with efficient ordering and stock-taking protocols.
- Optimize storage space by managing the correct quantity of material
- Explore bulk-buying deals to take advantage of discounts
- Compare different suppliers to get the best value for money
Summary
“Entrepreneurs believe that profit matters most in a new enterprise. But profit is secondary. Cash flow matters most.” – Peter Drucker.
The importance of maintaining a steady cash flow in your small business cannot be denied. A positive cash flow acts as a buffer, allowing the company to keep up with its expenses. It also has the potential to grow the business if invested at the right time. Using the strategies for cash flow management described above will enable you to calculate and forecast your cash flow, ensuring that your business stays ahead of its competition!