Business cash flow—it’s that one phrase that anyone working in finance knows all too well. It’s also a direct snapshot of a company’s financial health.
Cash defines the ability of your business to pay its employees and suppliers and handle operational costs. It’s essentially the life blood of the company, and managing it properly is a significant role of any owner or finance department.
Poor cash flow management is a large factor in how many businesses fail. Small business owners in particular should make sure they stay on top of their cash flow management, with an emphasis on exactly how much money is going to operating expenses, monthly expenses, capital expenditures, interest payments, and more. What can you do to perfect your cash flow management strategy, and what can you do if you fall short next quarter? Let’s talk about business cash flow and how to better manage it.
What is cash flow management?
Cash flow is determined by subtracting a business’ cash expenses from the cash amount received. That is, it is a measure of how much money is moving into and out of your business. Cash flow is distinguishable from profit, which measures money earned minus expenses over a period of time.
To be even more specific, operating cash flow refers to the money generated by normal business operations and business expenses, which can include non cash expenses (like depreciation). The amount of money needed to pay expenses is part of your cash outflow.
Free cash flow refers to the money a company has left after paying its operational expenses, as well as any investments or capital expenditures. Profitable investments will then be considered part of your cash inflow.
Net cash flow is the total cash inflow, or money received (including loans) minus the total cash outflow, or money spent (including debt repayments) in a given period.
Each of the above require you to take the appropriate cash flow measures for your business (and your bank account) to make an accurate cash flow projection and avoid harmful cash shortfalls.
Payments are not always made immediately, so how can you ensure that you’ll have enough cash on hand when the payment deadline comes in? It’s only after you receive the money or complete a payment does cash actually start moving. That’s why maintaining a positive cash flow is necessary for generating a profit. If at the end of a measured period your cash flow statement shows you have more money going out than you have coming in, you have a negative cash flow.
An important facet of financial management, cash flow management is the process of studying and optimizing your cash flow. The data points to pay attention to when managing cash flow include:
- Customer payment history, including seasonal sales fluctuations
- Upcoming expenditures like rent, sales tax, utilities, and benefits paid
- Payment deadlines from vendors
- Other information you can gather from your finance department and your sales representatives regarding sales income
Managing cash flow is an essential step towards ensuring the financial wellbeing of your company. It involves collecting information, making informed predictions called cash flow projections, and putting your plans into action.
Why does it matter?
A profitable business has to uphold financial obligations. Spending more than you make is never an ideal position to be in as a business owner. Sometimes, the problem is timing: there’s often a gap between the deadline to pay suppliers and employees, and collecting direct profits from customers. Achieving that desired cash balance is ideal and good cash flow management can ensure you maintain that balance.
Conducting a cash flow analysis to accurately calculate cash flow (which can include cash inflows, cash outflows, net income, debt payments, income statements, and more) at regular intervals will let you see potential issues before they become significant problems. Do so at least once a month or once a quarter. In dire situations, a look at your cash flow every week may be necessary to ensure you stay on top of your payments as well as your financial planning.
Why do businesses struggle with cash flow?
Cash flow can be a challenge to manage no matter the size of your business or whatever industry it operates in. While you might generate enough cash from sales to pay off your debts, what if the deadline to pay arrives before you receive the money?
The rapid expansion of a business can especially disrupt cash flow. For instance, your operational costs are higher while you’re hiring new employees, paying an increased rent and maintenance for new office space, or handling higher advertising or inventory management costs. Suddenly working with new vendors or suppliers will increase the amount of money in AP (accounts payable) that is owed, or having an influx of new customers could affect cash inflow via accounts receivable. Certain innocent practices can affect cash flow as well. Recording sales before they are paid, for example, like with accrual accounting can give a more accurate financial forecast but can cause invoice discrepancies that harm cash flow down the line.
Calculating cash flow can be nuanced and difficult for any financial institution, from small businesses who may need to borrow money, to large enterprises who seem to run the show. Keeping a true and updated log of all transactions, and consistently reviewing your income statement while comparing it to other periods and noticing changes, can ultimately help increase cash flow.
Modernizing and streamlining the way you manage your purchasing process is the only way to accurately plan and stay on top. But it requires some focus. Successful businesses must strike the right balance between revenue generated and expenses paid. A truly optimized operating cash flow (taking all operating expenses into account) takes many attempts and a lot of attention. When it comes to cash flow management, it’s all about timing and understanding the invoice and payment cycles your business relies on.
How to solve the problem:
Effective cash flow management is not a one-time consideration or a “set it and forget it” process. There are many factors to track, and a continuous effort is necessary to stay up to speed.
You can first optimize how your business handles cash receival. An important aspect of cash flow optimization is speeding up your ability to turn materials into products and services, and the conversion time from sales to cash.
Some steps to take are:
- Requesting an immediate deposit from customers for each sale. This will provide you with an immediate influx of cash, so you can cover short-term liabilities.
- Offering discounts to those who make payments quickly. Providing customers with an incentive to pay invoices fast can help your cash flow.
- Performing credit checks on new customers to ensure disruptions are unlikely to occur. Credit checks are an important part of doing proper due diligence. They help you minimize risk by identifying unreliable customers and vendors before they become a problem.
- Issuing invoices quickly. While it may seem easier to issue invoices and other financial statements in a larger batch, sending invoices as work is completed ensures a consistent flow of cash into the business.
On the other hand, you need to optimize how your business pays its suppliers and employees. Don’t make the common mistake of ignoring expenses only because sales are high. If you don’t take control of cash flow, you will likely run into costly payment delays.
Here are a few tips to keep in mind when it comes to managing cash flow and common aspects that may impact your ability to do so.
Working with suppliers
When it comes to managing payables, take advantage of payment deadlines. Some creditors will allow you to make a full payment before a certain date, so there’s no reason to pay too quickly.
Paying something too early is an opportunity cost for your business. If a deadline isn’t for a month, there’s no need to pay an invoice early. Give yourself some breathing room. Spacing out your expenses and maintaining positive cash flow ensures you have liquid cash available to pay invoices, unexpected costs, and most importantly—your employees salaries.
Be transparent about your financial situation to your suppliers. Remember, building trust goes a long way. Suppliers you have good relationships with will be more willing to forgive a delay in the future, protecting your business when it matters most. A business that can plan for the future will likely be an excellent customer after all.
Don’t forget that choosing the right supplier is part of the job. The lowest price isn’t always the best option. A supplier with more flexible payment terms can be better for your cash flow in the long run, even if the initial investment is higher.
Analyzing cash flow
Develop cash flow management strategies on a regular basis. With the data you collect, make predictions regarding your financial status and determine your next steps. For instance, if you forecast a short-term cash flow problem, consider extending credit to other businesses, or shortening the cash flow conversion period to receive money faster.
The latter option is known as debt financing, where you take out a business loan from an investor while your own company is growing. In debt financing, you use your own assets like equipment or property as collateral for the loan. The advantage is that you retain control of the organization without giving up partial ownership to the creditor.
Equity financing is another way to raise money by selling shares to investors. The risk here is lower for the owner since you don’t have to repay the debt if the business does not succeed. However, the investor does take a share of the profits and will have part ownership. That investor has some say when it comes to future business decisions.
No matter which option you choose, you will have to demonstrate the need for financing to your investors. Have a business plan ready to present.
Finally, don’t forget the most obvious way you can solve cash flow problems: cutting unnecessary spending. Make sure all departments are working cohesively so that maverick spending does not occur. Find out whether your investments are making proper returns before you consider renewing them.
What to do when you fall short
No matter how well you manage cash flow, there will likely be times when you don’t have enough money on hand to cover the bills. This situation is natural for most organizations, and dealing with it is part of owning a business.
The solution is to act proactively and be aware of the situation early on. Banks are more likely to give business loans to owners who can plan ahead, so predict a shortage in advance before asking for one. Another option is building a line of credit at the bank, which allows you to borrow up to a certain limit. This can help you weather short-term cash flow issues.
Next, talk with your suppliers. They are closer to you than the bank and are more invested in your success. Ask for low-cost loans if necessary or a delay on one of your payments. Don’t forget to talk with clients as well. Stay on top of your invoicing and offer incentives for early payments.
If you’re in need of cash but your customers haven’t finished their payments yet, think about working with a financial intermediary known as a factor. This way, you gain extra cash without borrowing money, though the factor will ask for a discount during the arrangement (typically around 15%).
As a last resort, sell company assets like furniture or equipment, especially for capital assets nearing the end of their lifecycle.
Once you have the money, prioritize which bills you pay off first. Unpaid employees and primary suppliers should be at the top of the list. Avoid wasting money on minor bills when larger ones still loom.
Let accounting software help
Technology is one of the biggest advantages modern companies have when it comes to financial processes, and more business owners are turning to software solutions to manage their spend. Whether you use these tools to automate, optimize, or enhance these processes—the end result is powerful functionality where it matters most.
Platforms like these help you collect illuminating information into your financial situation and monitor the cash flow of your company. This data will generate actionable insights to help plan the next move.
Cash flow management services use the power of the cloud to modernize your spending operations. Using machine learning, they give you full visibility into all cash flow processes going on in a business’ procurement process. It’s essentially a way to accelerate bookkeeping, one of the most important ways to record and understand the way cash flows through your business.
Approve.com is a procurement solution that puts your financial activities front and center, not letting important documents or information fall through the cracks, helping to stay organized across teams and eliminate maverick spend. All stakeholders involved can see status updates throughout the approval flow, and finance teams get valuable data that helps them plan and make smarter predictions. In addition to streamlining approval processes, it integrates well with your ERP and other systems in place so that you can hit the ground running.
Enabling easy collaboration among your teams is much easier through a dedicated service. This way, you can generate cash flow statements, balance sheets, and other essential records for quick and easy reference by anyone in the company.
Are you staying on top of your cash flow management?
Proper cash flow management isn’t just important—it’s essential today. And with so many powerful solutions on the market, there’s no reason to cut corners.
Approve.com can help you keep an eye on your cash flow, as well as all purchasing activities in your organization with streamlined approval flows, enhanced communication between stakeholders, and a customizable easy-to-use platform.