Closing the Gap: Effective Cash Flow Management

“Cash is king”. Have you ever rolled your eyes when you’ve heard someone make this statement? While we can all agree that it has become a business cliché, the root of its meaning does have merit. While revenues, profit, and even market share are all indicators of success, if there is no cash in the bank to meet monthly bills, pay employees or make your loan payments then any business will ultimately fail. By taking the time to understand and analyze your cash
flow, you will be taking the necessary steps to ensure your business is growing and healthy.

Understanding Cash Flow

Most business owners believe their cash flow is defined as profits. This is simply not true. It is possible to project a healthy profit for the year and yet face a significant and costly monetary squeeze at various points during the year. This periodic challenge could be so drastic that you may worry whether your company can survive.

So, if your profits are not cash flow, then what exactly is it? In its simplest form cash flow is the movement of money in and out of your business.

Inflows are from the receipt of money from the sale of your goods/services to customers, receipt of money on customer accounts outstanding, proceeds from a bank loan, interest received on investments, or investment by shareholders in the company.

Outflows are most likely the purchasing of raw materials and other components needed for the manufacturing of the final product, investment in inventory for re-sale, paying salaries, wages and other operating expenses, purchasing fixed assets, paying principal and interest on loans, or paying taxes.

One of the biggest issues in managing your cash flow is that outflows and inflows seldom seem to occur together. More often than not, inflows seem to lag behind your outflows, leaving your business short. This money shortage is your cash-flow gap. By properly managing your cash flow you can effectively narrow if not completely close this gap. You accomplish this through a careful examination of the various cash inflows and outflows that affect your specific business.

Analyzing Cash Flow

To properly manage your business’s cash flow, you must first analyze the components that affect the timing of your inflows and outflows. A good analysis of these components will point out problem areas that lead to cash flow gaps for your business. The main components that you can manage are:

Accounts Payable – While it is good cash-flow management to delay payment until the invoice due date, take care not to rely too heavily on your trade credit and stretch your goodwill with suppliers. Paying bills late can indicate that you are not managing your cash flow the way a successful business should. You should take into account your suppliers’ terms of trade – to which you will already have agreed.

Inventory – Monitor when and why you need inventory. An excessive amount of inventory hurts your cash flow by using up money that could be used for other outflows.

Accounts receivable – If credit is normally extended to your customers, the payment of accounts receivable is likely to be the most important source of cash inflows. To properly manage your cash flow, you must know the negative cash flow affects caused by the time it takes your customers to pay on their accounts. A very important element of managing your accounts receivable is your company’s credit policy.

A credit policy is the guidelines that spell out how to decide which customers you extend credit to, the exact payment terms, the limits set on outstanding balances and how to deal with delinquent accounts. The correct credit policy is necessary to ensure that your cash flow doesn’t fall victim to a policy that is too strict or to one that is too generous. A credit policy that is too strict will discourage potential customers and reduce sales, eventually leading to a decrease in the amount of cash flowing into your business. On the flip side, if your credit policy is too generous it will attract slow paying or even nonpaying customers and lead to cash inflow issues.

Cash Flow Budget

You would be shocked and amazed at the number of businesses that fail because the owner did not see a cash flow problem in time to do something about it. The key is to always be able to answer the question – what do I expect my cash balance to be six months from now? The best way to achieve this is to do a cash flow budget. The cash-flow budget projects your business inflows and outflows over a certain period of time. You can put together a cash flow budget by estimating the amount and timing of the inflows and outflows of your business.

• Opening cash balance
• plus Projected cash inflows
• less Projected cash outflows
• equals cash-flow bottom line (the closing cash balance)

After this analysis has been completed and added or subtracted from the beginning cash balances, the likelihood of shortfalls may be ascertained and you can prepare yourself to handle any gap that exists.

Fill Your Cash Flow Gaps
If a gap is predicted early enough, you can take cash-flow management steps to ensure that the gap is closed, or at least narrowed in order to protect your business for the future.

There are three basic ways for you to improve your cash flow position. They are:

• Accelerating your cash inflows
• Delaying your cash outflows
• Minimizing operating expenses

If there is a need for additional funds, either to meet short-term shortages or for longer-term growth, there are several sources of new funds that can be considered. These include an overdraft facility with a bank, establishing a short-term revolving borrowing facility, long-term financing from a bank or other institutions, factoring, or an equity investment.

Cash Flow Surplus

If you are managing and improving your cash flow, this will hopefully result in a cash surplus for your business. A cash surplus is the cash that exceeds the cash required for day-to-day operations. Like so many other things you do for your business, deciding where to use your cash surplus requires some planning and your better judgment. The most common uses are paying down your debt, investing in capital projects, payments to stakeholders or placing the cash surplus in short term investments so that you have cash for a “rainy day”.

The effect of cash is real, immediate and, if mismanaged or not managed at all, very unforgiving. By properly managing your cash flow, you will know where your cash is tied up and you can spot potential bottlenecks and act to reduce their impact. Focusing on understanding and managing your cash flow each month allows you to be in control of your business. As a result it will be dramatically easier to make informed decisions about how to grow your company.

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