Why Good Cash Flow Management Is Vital for Company Survival and Growth
Cash flow management is how you track, analyze, and optimize the movement of money in and out of your business. If you run a profitable business and manage your cash flow well, you should always have enough in your bank account to meet your day-to-day financial liabilities. Better still, over time, you’ll be able to build up a healthy reserve of money to meet unexpected expenses or invest in growth opportunities.
Read on to find out the benefits of managing your cash flow well, as well as 21 different ways you can improve your company’s liquidity. Then learn about some great tools to help you manage your business finances more efficiently.
The Benefits of Managing Cash Flow
The key benefits that effective cash flow management provides businesses of all sizes include:
Financial foresight: You’ll be able to spot potential cash shortfalls well in advance so you have the time you need to address any issues before they become potentially serious cash flow problems.
Growth planning: You’ll also be able to predict any future cash surpluses, meaning you’ll be better able to budget for growth and be safe in the knowledge you won’t be overextending yourself financially.
Lender and investor trust: A well-run business with strong cash flow management and clear financials will enjoy more success when applying for credit from financial institutions and suppliers and will also attract more interest from investors.
Greater resilience: Profitable businesses that manage their cash flow well can build up reserves of cash in their bank accounts. They can use these reserves to handle unexpected expenses and downturns in sales or to capitalize on opportunities that demand immediate action.
Accounting compliance: Keeping an eye on your cash flow means that you have to regularly and closely monitor your company's financial records and transactions. This leads to more accurate financial reporting that’s compliant with regulatory requirements.
The Different Types of Business Cash Flow Analysis
There are a variety of approaches you can use to analyze and manage your company’s cash flow. Each method gives business owners valuable insights into their financial position so they can improve overall liquidity, manage risk, and plan for growth.
The three main types of cash flow analysis are:
Operating Cash Flow
Operating cash flow shows you how much cash your business generates from its core business activities after you’ve paid out on operating expenses. It doesn’t include any gains or losses you’ve made from investments in real estate, securities, or other assets.
To work out your operating cash flow, add the following three items together:
Net income (sales from core activities minus business expenses related to your core business activities like wages, equipment costs, and insurance)
Noncash items (includes depreciation, amortization, deferred taxes, compensation paid out but not in cash, and more)
Changes in working capital (includes the level of inventory held and the size of your accounts payable and accounts receivable ledgers)
The operating cash flow metric is useful for determining whether you have or will have enough cash to fund expansion, increase wages, invest in new products and services, and return higher dividends to shareholders.
Company owners and investors also monitor operating cash flow to determine how well a firm manages money on an ongoing basis.
Free Cash Flow
Free cash flow is a broader definition of a company’s cash flow than operating cash flow. It includes what you spend on longer-term capital expenditures like real estate, equipment, and vehicles your firm owns. By subtracting these costs, you get a clearer picture of how much cash your business generates after paying for the assets it needs to operate.
To work out your free cash flow, simply subtract your capital expenditures from your operating cash flow.
Free cash flow is a very useful metric for business owners and investors to determine how much cash a company has to:
Reinvest in growth: This includes activities like developing new products, expanding business operations, and purchasing new equipment and machinery.
Manage debt: This includes existing arrangements with financial institutions and servicing any new business finance package a firm may wish to take out.
Return value to shareholders: This includes issuing dividends and buying shares back to increase shareholder value.
Company owners and investors consider free cash flow to be important because it can give a reliable indication of how well a business can meet its commitments in the long term, as well as its ability to survive in the short term.
Cash Flow Forecasts
Cash flow forecasts, sometimes called cash flow projections, are useful for determining how much money is likely to be in your business at a future date. Cash flow forecasts are often made for the coming month, quarter, or year.
To work out what your likely future cash flow might be, you start with a beginning amount of cash (for example, your current cash position), then add your expected cash inflows, and finally subtract your expected cash outflows.
Cash flow forecasts are useful for business owners because they highlight:
Whether you’ll have enough money to meet your financial obligations
How much cash your business needs to manage its day-to-day operations
The level of cash you’ll need to invest in growth, take on new staff, pay down debt early, and more
21 Strategies for Effective Cash Flow Management
Cash flow analysis gives business owners the foundation they need to improve their companies’ financial positions. Below, find 21 ways you can manage your cash flow to ensure you have more money in your business.
1. Invoice Faster and More Often
Don’t invoice your customers on a monthly cycle for all the work they’ve accumulated. Instead, send out invoices as soon as you’ve completed the work. This way, you’ll have more money to see you through the month to meet your financial commitments.
2. Ask for a Deposit or an Upfront Payment
For large orders or long-term projects, ask for a deposit or an upfront payment from your customer. This is not for the whole amount but for a percentage, like 20% or 50%. This payment will help cover initial costs and reduce any potential losses you have to cover if the customer can’t or won’t pay their final invoice. Be sure to let customers know when you’re selling your product or service that you expect a down payment so it doesn’t come as a surprise.
3. Start Rigorously Credit-Checking Customers
Many firms offer their business customers credit accounts, meaning that they can settle an invoice 30 to 90 days after it has been issued. Yet, late payments or nonpayments can cause real cash flow issues. Consider working with a credit reference bureau to determine what maximum credit limit you should set for individual customers based on their payment history and financial stability. If a client wishes to spend over their limit, you can refuse to fulfill the order until they make a payment to bring down their outstanding balance, which means you’ll get your money faster.
4. Use Invoice Factoring
If you want to offer credit accounts but your current cash flow wouldn’t allow you to offer a 30- to 90-day payment window to clients, consider working with an invoice factorer. They transfer 90% of the invoice value to your checking account within 24 hours, paying you the remainder minus their fee when your customer pays their invoice. Factorers set limits for each customer individually based on their business credit score.
5. Offer Early Payment Discounts
Some customers may not be keen on invoice factoring and may prefer to be billed directly by you. In those cases, you could offer them an early payment discount. This will not only improve your short-term cash position but will potentially strengthen your relationship with customers who appreciate the chance to save money.
6. Provide More Ways for Customers to Pay
Not all companies want to make business-to-business payments by check or an Automated Clearing House (ACH) payment. Around half of all U.S. companies now make regular payments by credit card, while others might prefer PayPal. For high-ticket items, consider offering a finance option like equipment leasing where they can spread payment out over a number of years. Boost your cash reserves by making payment as easy as possible for your customers.
7. Negotiate Better Supplier Prices and Terms
The suppliers you use most regularly may be open to discussing pricing and terms. You could ask your suppliers for more time to pay so you have a chance to generate revenue from an order before you settle your invoice. You could also ask them to offer a discount if you settle before the due date, thereby reducing your own costs and increasing your profit margin. Another alternative, particularly on larger orders, is to seek an inventory financing package — your supplier may be able to help you with this.
8. Defer Your Own Payments
Look for opportunities to extend payment terms on other items like equipment leases, utilities, and rent. You could start using a business credit card to pay for secondary expenses like travel costs or office supplies, which aren’t as critical as wages, rent, inventory, and debt repayments. Using your credit card will help you to spread repayments out over time. Taking this approach means you hang on to your company cash for longer.
9. Consider Equipment Financing
Buying the equipment, machinery, and vehicles you need to keep your business running outright using an upfront payment can significantly deplete the amount of money you hold in your business checking account. By using equipment financing instead, you spread the cost over multiple years, and there may be tax benefits, too — but check with your accountant.
10. Reevaluate Your Business Operations
Look at the range of products and services you offer. If certain items yield less profit and take more time, money, and effort to sell than others, there may be a case for discontinuing them. You could also outsource non-core functions like IT support and marketing, going from full-time employees to freelancers or third-party providers to bring down your fixed cost base.
11. Look for Alternative Sources of Revenue
Your competitors may sell products and services that you’re not currently providing to your clients. Offering them to your customer base could be a great way to generate additional revenue, as well as to make your customers more dependent on your business. You could charge a premium for enhanced customer support or for training clients on how to get more from their purchases. By providing your customers with more choices, you create more selling opportunities and reduce your dependence on a limited range of sources of income.
12. Optimize Your Inventory Levels
Inventory management is closely tied up with general cash flow management. Monitor your inventory to make sure that you’re not overordering particular items, while still being able to meet demand. Not all inventory sells quickly, so consider selling underperforming items at a discount to free up cash.
13. Implement Cash Flow Forecasting
Prepare cash flow statements and forecasts regularly so you have a clear picture of your current and future financial position. Use the data in your historical statements when producing forecasts, as this may help make them more accurate. By doing this regularly, you’ll be better able to spot trends in advance and adjust your strategy going forward. This can be particularly helpful if your business is affected by seasonality.
14. Run Regular Internal Financial Audits
Creating regular cash flow statements and forecasts will provide you with a solid foundation for performing routine internal financial audits. These audits can help you spot inefficiencies in your business, detect potential fraud, and ensure overall financial accuracy. Moreover, they can help you uncover further areas for improving the financial management of your business to reduce the likelihood of future cash shortages.
15. Monitor Your Financial Performance
Work out which financial key performance indicators you want your business to hit on important metrics like cash conversion cycle and days payable outstanding. The data you use in your forecasts and internal audits will help you spot areas for improvement and provide senior managers with the information they need to make decisions on cash flow management and general business strategy.
16. Secure Financing Before You Need It
Forecasts can help you spot periods of projected positive cash flow and negative cash flow well in advance. If you’re forecasting a downturn, set up financing options like a business line of credit and short-term loans like working capital advances ahead of time, just in case you do need them. Be sure to include your forecasts in your finance applications so you can show lenders how and when you’ll be able to repay them.
17. Create Multiple Savings Pools
Many online banks now allow you to create separate cash pools linked to your primary checking account. For example, you can instruct your banking app to set aside 10% of incoming revenues for a sales tax pool, 15% for a future inventory order pool, and 20% for a savings pool.
The benefits of this approach are threefold:
You’ll have a clear picture of how much cash actually belongs to your business.
You’ll have separate pools of cash to pay tax bills and supplier invoices.
You’ll build an emergency fund to handle unexpected expenses or economic downturns.
18. Open a High-Interest Savings Account and Invest in Liquid Assets
If you find that you constantly have high surplus cash balances, you could open a high-interest savings account or buy government bonds to earn a fixed income. If you’re feeling more speculative, you could invest surplus cash in securities, although there is a risk of loss if prices fall. Whichever course of action you take, choose savings accounts and assets that you can liquidate quickly and cheaply in case you need the capital.
19. Send Out Clear Credit Terms and Policies to Clients
Be absolutely clear from the first time you deal with customers what you expect of them by sending them clear credit terms and policies. Make sure that the due date is prominently shown on each invoice, and outline any late payment penalties (including the interest rate) and early payment incentives. Whenever you make a change to your credit and payment terms, inform all of your customers as soon as possible.
20. Send Out Reminders and Chase Overdue Invoices
While clarity on payment terms is helpful, many firms will still wait to be chased before they settle invoices, so it's important to be proactive and consistent in your follow-ups. To improve your chances of enjoying a healthy cash flow, send them reminders when a payment is about to become due and actively chase up every overdue invoice.
21. Analyze How Each Customer Pays You
Make sure that you carefully monitor individual customers’ payment patterns. If you identify a late payer, consider shortening the length of time they have to settle their invoices, reducing how much credit you’ll extend them, or both. Likewise, you can incentivize clients who pay you on time with a longer credit window and a higher credit limit.
Tools to Help You Manage Company Cash Flow Better
To help you manage your company cash flow better, consider introducing one or more of the following software-based solutions into your business.
Microsoft Excel/Google Sheets: You can build your own forecasting and management tool in Excel or Google Sheets to forecast your business’s cash flow, or download one of the many templates that are available for free online. This is a manual process, so you’ll need to personally keep the spreadsheet up to date to ensure that your projections are accurate and relevant.
Accounting and bookkeeping software: Many leading accounting and bookkeeping packages contain cash flow forecasting tools as well as features to help you invoice customers and collect payment from them faster. For small business owners with lower transaction volumes, these tools provide a one-stop and easy-to-use solution for cash flow management as well as general bookkeeping and financial reporting.
Automation software: These are tools that plug into your accounting software to streamline how you manage accounts receivable and payable processes in your company. For example, accounts payable automation apps enable faster processing and approval of your invoices, show you in real-time which invoices are overdue, and provide ongoing visibility on your current and future cash balances.
Specialist software: Apps like CashAnalytics, Pulse, and Scoro allow firms to gain a much deeper insight into their cash flow and overall financial health. They constantly analyze accounts payable and receivable data for predictive forecasting and engage in scenario planning to assess the impact of various business decisions and market conditions on future cash positions.
The Importance of Cash Flow Management for Entrepreneurs
When you manage your company’s money well, you’re setting up your business to withstand tough economic times and to take advantage of transient opportunities when they arrive. To boost your business cash flow, focus on these three key areas: getting paid faster, managing your inventory smarter, and negotiating better deals with suppliers.
Careful financial management of your business leads to many other benefits. You can make your firm more efficient, streamline your range of products and services to focus on the most profitable, and reduce your operating expenses.
Financial institutions, suppliers, and investors will feel more confident dealing with you, too. Good cash flow management reassures them that you’re more likely to have the capital you need to pay bills and handle unexpected invoices without approaching them for more financial support. It’s a big vote of confidence in your and your senior team’s ability to manage your company successfully.
If you believe you’ll need additional capital to tide you over a quieter business period or to meet a bill you hadn’t anticipated, Backd may be able to help you.
We offer the following two financial packages to clients:
Working capital advance: Borrow up to $2 million over 16 months with flexible repayment options.
Business line of credit: Access up to $750,000 (subject to application) of funding and repay within six or 12 months.
Apply now, and be funded in as little as 24 hours.
