When it comes to managing and growing a company, cash is king. Cash flow problems stem from the delay between the time you have to pay your suppliers and staff and the time you can collect from your customers. Any small business owner can face challenges regarding cash flow management. You need to pay your bills, but your customers seem to put off paying their invoices until the last possible minute. Now you’re running on a tight budget, and you’re afraid your business will get into trouble.
Your worries are not unfounded since surveys show that most businesses fail because of difficulties in managing cash flow. Start-ups are particularly vulnerable because of the debt they incurred to fund their operation. Companies undergoing expansion can also run into problems since they have to rent additional space, buy more equipment and hire new employees.
At its core, cash flow management means finding a balance between cash coming in from customers, and cash going out of your business. This may sound simple, but it’s much more intricate in practice. Understanding what cash flow is and the difference between cash flow and profit will help business owners learn how to apply critical cash flow management strategies.
What Is Cash Flow?
Cash flow refers to the net amount of cash or cash-equivalents that’s going (flowing) in and out of your business in a month. The cash coming in is from customers or clients who are buying the products or services your company sells while the cash going out is in the form of payments for operational expenses such as rent or mortgage, taxes, loan payments, staff salaries and accounts payable (the money a company owes to its suppliers).
In case customers don’t pay at the time of the purchase, some of the cash flow will result from collecting accounts receivable. Accounts receivable, also referred to as “receivable” or “A/R,” are payments owed to a business, and they’re considered high on the list of business assets because they become cash as soon as they are paid. When faced with cash flow problems, businesses can use accounts receivable factoring or invoice factoring to obtain money for immediate needs.
There are three types of cash flow depending on the source. Operating cash flow relates to cash generated by the company’s main business operations. Investing cash flow comes from investment activities such as purchasing assets or other business ventures. Financing cash flow refers to cash flow generated by transactions involving debt, equity and dividends.
A company that can generate positive cash flow shows its ability to create value for its shareholders since it can add to its cash reserves and can afford to settle future debt payments or reinvest in the company.
Cash Flow vs Profit
Cash flow and profit are related, but they’re not the same thing. Profit is part of a company’s cash flow, and it’s what remains after all business expenses have been paid. A company can make a profit but still have cash flow problems. How is that possible? When a company makes a sale to a customer and issues them an invoice, that sale will appear in the company’s accounts immediately, but that customer may not pay that invoice for 120 days. As the business owner, you are entering a debit for your inventory and a credit for accounts receivable. As per your company’s accounts, you have generated profit, but you still haven’t received the cash for that sale. This profit won’t pay your operational costs. You have assets in the form of receivables, but if you can’t collect them, you won’t have positive cash flow.
Cash Flow Management
As we already mentioned, the key to cash flow management is to bridge the gap between cash flowing in and cash flowing out. Sooner or later, you might find yourself in a situation where you don’t have enough funds to pay your bills. This doesn’t mean you’ve failed in your role as business owner because no even the most experienced entrepreneurs can predict the future flawlessly.
You wouldn’t have any cash flow problems if you were paid for sales the instant you made them but, since this doesn’t happen, there are still strategies you can use to protect the financial health of your business.
Credit Policies and Customer Credit History
An important step in safeguarding your business against cash flow problems is weeding out those customers with a history of slow payments. You’ll also want to perform credit checks on any new customers. You’re not obligated to extend credit to just anyone. With some customers, you may have to change credit terms or refuse credit entirely, although you should do this as tactfully as possible.
Invoice Promptly to Speed Up Payments
When you postpone invoicing, your customers can get the impression that you don’t mind delays in payment. You want to encourage prompt payments by clearly stating due dates and issuing overdue notices. You can also offer discounts to customers who pay their bills quickly and use collection services when necessary.
Deposits and Partial Payments
For large orders, it’s common practice to ask for deposits or partial payments. For example, you can ask for a 30% deposit when the order is made, and the rest after the client receives the products or services. The percentage depends on the industry sector you’re working in.
Holding too much inventory ties up cash and negatively impacts cash flow. You’re losing money because of the cost of storing it and paying employees to manage the storage space. By keeping track of your inventory, you’ll know how much you have, how much it’s worth and can estimate how much you’ll need.
Part of successfully managing cash flow is overseeing your expenses. If your reports show that your expenses are growing at a faster rate than your sales, you need to find ways to cut costs. You can also use electronic transfers to schedule payments on the last day they are due, which allows you to retain the use of your funds for as long as possible. If you need delays, don’t hesitate to contact your suppliers and renegotiate terms.