Cash flow describes the funds that flow in and out of a company and are used to run its daily operations. Good cash flow management means a business will always have enough available to take advantage of opportunities and pay its debts as they arise.
They say cash is king when it comes to the health of any business and for good reason. Having sufficient cash available when required is imperative to your company's survival and growth. In this article, we will define cash-flow and outline some techniques you can use to optimise your business' cash position.
What do we mean by 'cash flow?'
Cash flow refers to the monies that flow into and out of a business; cash inflows and cash outflows. Business cash flow is very important and should not be confused with profitability, as even profitable companies can fail if operating activities do not generate enough cash to stay liquid.
Good cash flow management means a business will always have capital on hand to pay its liabilities and take advantage of market opportunities as they arrive.
1) Raise your invoice promptly
Your customers' accounts payable team will appreciate a consistent invoicing process. Ideally, an invoice is raised and sent to the customer on the same day your service is completed.
Even if your payment terms are 30 days from the end of the month, you will want to get in the queue as soon as possible so there are no excuses when it comes time to collect. Cloud-based accounting software now makes it very easy and efficient to raise your invoices quickly.
2) Set clear expectations
When you start supplying a new customer, payment terms will be agreed and should clearly be defined in writing (service agreement). Setting clear expectations at the start of the relationship will also be helpful when it comes time to collect.
Don’t forget, your customer will also be managing their cash flow and trying to extend the terms of their payables wherever possible. You may also consider allowing customers to pay with different methods. Offering your customers' payment options like credit cards, or direct debit may make it easier for your customers to pay, especially small amounts.
3) Prepare cash flow projections
Regular, well-prepared cash flow forecasts allow you to see any possible future shortcomings in capital and plan ahead. It will also allow you to plan and smooth cash flows. Poor cash flow management may result in holding excess cash in the bank one month, then not having sufficient funds to pay your creditors the next. Cash inflows and outflows do not arrive at regular intervals, therefore short and long-term forecasting is imperative.
A short-term shortage of working capital at one point in time is not a sign that the business is doing poorly. Fast-growing companies will experience more cash shortages as they need to pay for more and more services upfront whilst they wait for larger and larger amounts to arrive from the accounts receivables. Seasonal businesses also suffer from cash shortages regularly. A good forecast will give you the foresight to save money for the off season or set up a line of credit to fill the gaps.
In business, it makes sense to always negotiate shorter payment terms with your debtors and longer terms with your supplier. Obviously, these terms have a direct impact on the company’s cash flows and the amount of working capital at its disposal. Working capital typically has a cost attached, as money that is not earning interest is effectively depreciating. However, by extending your creditors payment terms you will effectively use their funds as your working capital. Obviously, be careful not to damage the relationship here. If you’re forecasting negative cash flows, you may consider offering customers a discount for early payment. Vice versa, if your cash flow projection shows a surplus of cash flow you may want to take advantage of an early payment discount offered by your creditors.
5) Have a plan b
The importance of positive cash flow in business is clear and business owners should always monitor their receivables, payables and cash flow forecasts. However, the best forecasts cannot cater for unexpected events such as the insolvency of a key customer. In such an event, additional cash will be required and fast. Having a line of credit, or some contingency cash plan will ensure that you can keep your business operational during challenging times. Your backup plan should be ready from day one as you will never know when it will be required.