When it comes to the financial management of any business, it’s often said that Cash Is King! Whether your business is growing or struggling, managing your cash flow effectively is essential, and for many, it’s the key to business survival. You’ve probably heard the statistic that over 60% of businesses that fair are still profitable, but just ran out of cash.
If you’ve used a lot of your working capital, you may come up against a cash crunch that prevents you from paying suppliers, buying materials, and even paying salaries. The time delay between the time you must pay your suppliers the time you receive money from your customers is the problem, and the solution is cash flow management.
That’s why it’s critical to maintain a level of working capital that allows you to make it through those crunch times and continue to operate the business. Simply put, cash flow management means delaying outlays of cash if possible while encouraging your customers to pay it as quickly as possible.
Before we delve into the strategies to improve & manage cash flow in your business, let’s first look at the basics of cash flow management.
Important Cash Flow Basics
So, what is cash flow? It’s the movement of funds in and out of your business. Typically, businesses track cash flow either weekly, monthly, or quarterly. There are essentially two kinds of cash flows:
Positive cash flow: This occurs when the cash entering your business from sales, accounts receivable, etc. is more than the amount of the cash leaving your businesses through accounts payable, monthly expenses, employee salaries, etc.
Negative cash flow: This occurs when your outflow of cash is greater than your incoming cash. This generally means trouble for a business, but there are steps you can take to fix the negative cash flow problem and get into a positive zone. Cutting business expenses is one of the quick fixes, we’ll discuss more strategies in detail soon.
These critical numbers tell you just how much is coming in and how much is going out of your business. Making more than you’re spending? It’s all good. Cash flow regularly edging into the negative zone. Not so good.
Profit Does Not Equal to Good Cash Flow
You can’t just look at your profit and loss statement and get a grip on your cash flow. Many other financial figures feed into factoring your cash flow, including accounts receivable, inventory, accounts payable, capital expenditures, and taxation.
Effective cash-flow management requires a laser focus on each of these drivers of cash, in addition to your profit or loss. Rules of accounting define profit simply as revenue minus expenses. However, a smart business owner understands the fact that whether you earned a profit is not the same as knowing what happened to your cash.
Find Out Your Breakeven Point
You should know when your business will become profitable, not because it will affect your cash flow — because it won’t — but because it gives you an early goal to strive for and a ready-made target for projecting future cash flow. Negative cash flow and negative profits make for a grim combination. Focus your efforts on managing your cash flow to reach that moment when you realize your first profits.
You Can’t Control What You Don’t Measure
Finding out the amount of working capital a business needs to operate is the first step. You need to answer questions like:
- How much inventory do I need to hold?
- How many invoices are overdue?
- How much cash is tied up in work in progress?
- How long does it take from paying our suppliers for the materials to extracting cash from the customers?
How To Fix Cash Flow Problem In Your Business – 5 Tips
Now that you have a fair idea about cash flow basics, let’s see how you find solutions to cash flow problems:
1) Short-Term Financing
Short-term financing such as a line of credit can be used to make emergency purchases or to bridge the gap between payables and receivables. Many banks issue business credit cards that you can use to pay your vendors.
2) Long-Term Financing
Large asset purchases such as equipment and real estate should usually be financed with long-term loans rather than with your working capital. This allows you to spread the payments over the average life of the assets. You’ll be paying interest, but you’ll have preserved your working capital for business operations.
3) Speed Up Recovery of Receivables
Invoice early, collect quickly. To guard against late payments, invoice as early as possible and make those invoices as clear and as detailed as possible. It may also be worth changing other invoicing practices such as invoice frequency. Instead of waiting until the end of the month, generate an invoice as soon as the goods or services are delivered.
For big orders, you may want to consider progressive invoicing while you manufacture the goods or deliver the service. For example, you can ask for a deposit with the order and then a percentage of the payment at various agreed-upon milestones.
It’s easy to lose track and then neglect to follow up on an overdue account. Experience shows that the longer you remain out of contact with a customer, the less likely you are to recover the amount owed. You can even consider offering discounts to customers who pay their bills rapidly.
4) Liquidate Cash Tied Up with Assets.
Do you have equipment you no longer use or inventory that’s becoming obsolete? Consider selling it to generate quick cash. Idle, obsolete, and non-working equipment takes up space and ties up capital which might be used more productively. Equipment that has been owned for a longer period will usually have a book value equal to its salvage value or less, so a sale might result in a taxable gain. This gain should be reported on your tax filings. If you must sell below the book value, however, you will incur a tax loss, which can be used to offset other profits of the company.
Excess inventory can quickly become obsolete and worthless as customer requirements change and new materials are introduced. Consider selling any inventory which is unlikely to be used over the next 12 months unless the costs to retain it are minimal and the proceeds from a sale would be negligible.
5) Delay Your Payables
This may sound obvious but it’s often neglected. Unless there’s a worthwhile incentive for you to pay early, figure out how late you can pay your vendors without risking late fees or harming your relationship. This keeps the cash in your account and out of your vendors until it has to be there.
Small business owners usually learn one principle early in life – “Cash is king”. Building and keeping an adequate stockpile of cash provides maximum opportunity and flexibility to any business while enabling its owners to sleep soundly at night.
Without cash, profits are meaningless. Many a profitable business on paper has ended up in bankruptcy because the amount of cash coming in doesn’t compare with the amount of cash going out. Firms that don’t exercise good cash management may not be able to make the investments needed to compete, or they may have to pay more to borrow money to function.
Prosperity Accountants can help you create a Cashflow budget to help you anticipate inflows and outflows of money over a period. It’s important to start measuring the key metrics now.