Cash flow is like the pulse of a company and gives you the picture of the health of a business at a glance. Investors look for the cash flow statement before anything, to assess a business. A profitable business is not always a viable business, contrary to popular belief.
But whether you go for an investment or go bootstrapped, the whole thing that keeps your business moving is a higher net balance of the cash flowing into and out of the business for a sustained period.
This is the most basic, yet the most important factor that can take a budding business to a new height but may also cause a slow death to even a large business conglomerate. How? Take a look.
Your business has to earn enough money to pay off the suppliers, debtors, wages, and bills in time, and also save money to buy equipment, machinery, and assets. But in business, income differs from the collection, and there is often a situation when some payments remain outstanding. Therefore, actually it is the amount of cash inflow (collection of income), and not the income statement, that determines a company’s solvency.
For example, the income statement records revenue at the time a sale is made. Now the sale may have a 30 days payment term. Hence, until the full payment is collected, you’ll have to manage everything with whatever the cash is available to you.
This results in one of the common problems faced by businesses when the income statement shows a positive net income, but the cash flow statement shows a lack of cash to maintain its operations.
While small businesses can’t survive this situation for long, large companies develop a slow erosion, break assets to balance a negative cash flow, and eventually wind up.
Here comes the roll of cash flow management
Cash flow management is monitoring, evaluating, and optimising the cash inflow minus cash outflow in a business. Cash outflow refers to your business liabilities.
As long as your cash inflow can meet your cash outflow and still allows you to save some money, your business is healthy. If your cash inflow barely meets your liabilities and doesn’t allow you to save any money, your business is not growing. And, if your cash inflow is not enough to meet your liabilities, you are in trouble.
Why is cash flow management important?
According to one survey, 82 percent of businesses fail because of poor cash flow management. You have a cash flow problem if your company consistently spends more than it earns.
The most critical part of cash flow management for small businesses is avoiding lengthy liquidity shortages produced by a big difference between cash inflows and outflows. If you can’t pay your payments for an extended period of time, you won’t be able to stay in business.
That is why it’s vital to keep a level of working capital that helps you to pay your essential payments and also meet the operational cost. A simple method of cash flow management usually practised by the accounts dept entails deferring cash outlays for as long as feasible while pushing clients to pay as soon as possible.
Cash flow management processes
The cash flow process begins when you spend cash to buy materials and pay expenses such as employee salary. The next stages involve turning the supplies into inventory, selling the inventory, and receiving the money from the clients who purchased the products from you. The speedier the process, the faster you’ll get your money.
As a business owner, you must do a cash flow analysis on a regular basis and use cash flow forecasting to take the required steps to avoid cash flow problems. Many accounting software systems have reporting functions that make cash flow analysis simple. This is the initial stage in managing cash flow.
The second step in cash flow management is to devise and implement methods, such as the following, to maintain appropriate cash flow for your company:
Faster payment terms
Many B2B enterprises provide payment terms that give clients up to 90 days to pay for things that have already been delivered. This has two effects on cash flow. The products must be replaced in inventory, which requires cash, yet the cash from your customer is 90 days late. Increasing the terms to 30 or 60 days improves cash flow. The disadvantage is that clients may choose to purchase from another company that provides longer payment periods. Another option is to continue to provide generous payment terms while offering a monetary discount if payment is received within 30 days.
Check credibility of a new customer
When a new consumer places an order with you, request a deposit. You can offer the customer payment conditions after he has proved that he pays on time for the remainder of the invoice. Examine the accounts receivable ledger to see if customers have a pattern of paying late. It may be time to quit doing business with them and focus on customers that pay on time. Late-paying consumers can stifle your cash flow and make it tough to pay your vendors and personnel.
Factoring is a smart way to meet the immediate cash needs through selling some accounts receivables to a third party (called a factoring company) at a discounted rate. Factoring increases your cash flow in the short term while decreasing your profit margin.
Disposing non-performing assets
A small business may have idle assets that could be liquidated and turned to cash. However, selling an asset other than inventory results in a gain or loss on the sale, which affects your net income. It is a loss if the price you receive is less than the asset’s book value on your balance sheet. It’s a profit if the price is higher than the book value. In any case, the money you receive from the sale increases your cash flow.
Raise your prices, sell more, and cut your expenses.
You can enhance cash flow by raising the price of your product without losing sales. You enhance cash flow by selling more things without raising the price. When you reduce your expenses, you boost your cash flow. All of them are operational methods for increasing cash flow.
Short-Term loans can be utilized for emergency expenditures or to bridge the gap between payables and receivables. Many banks provide business credit cards that can be used to pay vendors.
Large asset purchases, such as equipment and real estate, should typically be financed with long-term loans rather than working capital. This allows you to spread the payments across the asset’s average life. You will pay interest, but you will have kept your operating cash for business operations.
Sell off outdated inventory and unused equipment
Do you have some outdated inventory or equipment that you no longer use? Consider selling them for quick cash. Idle, old, and non-operational equipment eats up space and ties up capital that may be put to better use. Equipment that has been owned for a longer period of time will often have a book value equal to or less than its salvage value, therefore a sale may result in a taxable gain. This profit should be recorded on your tax returns. If you must sell below the book value, you will incur a tax loss that can be used to offset other company gains.
Small-business owners in general focus on profit, failing to see that cash flow (having enough cash on hand to pay the bills on schedule) is as crucial. This may lead to severe cash crunch and even closing down of business.
Businesses can have a great top line or consistent bottom line earnings, but they can’t move forward without a positive and steady cash flow. When done correctly, cash flow management can suggest impending concerns and ongoing problems, as well as drive solutions.