Cash Flow Management: Everything You Need To Know
Cash flow management is at the core of your company’s financial stability, growth, and longevity. But what exactly is cash flow management, and why is it so vital?
Here’s everything you need to know, including common issues, the impact your payables and receivables might have, and some examples of cash flow management.
What Is Cash Flow Management?
Cash flow management is the process of documenting, monitoring, analyzing, and optimizing a company's cash inflows and outflows to:
- Get a clearer picture of financial health,
- Make informed decisions by understanding the amount of money your company has at any given point,
- Improve cash flow management, and
- Avoid potential cash flow crises.
Why Is Cash Flow Management Important?
Cash flow management is crucial in fulfilling these key functions:
1. Maintaining a Healthy Financial Position
By monitoring your company’s bank accounts, cash position, and liquidity in real time, you can ensure there are no funding shortages on the horizon.
2. Planning for Future Business Expenses and Opportunities
Effective cash flow management helps you track revenues and expenses in a practical way, identifying areas for improvement before they bite you in the butt.
With accurate cash flow management, you can avoid surprises, anticipate potential cash flow issues, and take proactive measures to mitigate risks.
3. Building Credibility
Demonstrating that your company’s cash flow is well-managed gives lenders, investors, and other stakeholders confidence that your business is financially stable and capable of meeting its financial obligations. This can open doors for funding opportunities, partnerships, and more.
4. Reducing the Need for Additional Funding
Finding funding sources when you have cash flow problems can become highly problematic. Effective cash flow management supports more informed, timely decision-making to help your company stay in business without seeking additional revenues or investments.
“Making more money will not solve your problems if cash flow management is your problem.” – Robert Kiyosaki.
How Accounts Payable & Accounts Receivable Affect Cash Flow
Accounts payable (AP) and accounts receivable (AR) play a significant role in cash flow management. For many years, I’ve worked with AP and AR teams on modernization initiatives to:
- Reduce or eliminate manual tasks like invoicing,
- Streamline operations, and
- Reduce processing time in payment management
Here’s how each function affects cash flow:
Accounts Payable’s Role in Cash Flow Management
AP is the money your business owes to vendors, suppliers, and other creditors, including inventory purchases, utilities, rent, and professional services.
Effectively automating and managing AP through simplified and efficient processes ensures there’s enough money to make timely payments and maintains good relationships with your suppliers.
Late payments might not seem like a big deal, but they can damage relationships, limit attractive payment terms, and disrupt your supply chain.
Accounts Receivable’s Role in Cash Flow Management
AR is money owed to your business, including sales revenue, outstanding invoices, and any other receivables owed to your business by customers and clients.
Managing accounts receivable involves timely invoicing, following up on overdue payments, and implementing effective credit control measures. Optimizing and automating your accounts receivable processes can accelerate cash inflow and reduce the risk of bad debts, aka those collections that never materialize.
To effectively manage both accounts payable and accounts receivable, you should:
- Establish clear payment terms and policies
- Streamline your billing and invoicing processes
- Maintain open communication with your suppliers and customers
Automating these two aspects helps you maintain a healthy cash flow and avoid unnecessary cash flow gaps.
Cash Flow Management Scenarios — The Good, The Bad, & The Ugly
To better understand how cash flow management works in practice, here are a few examples:
Scenario 1: Positive Cash Flow
Company A has a well-established customer base and steady sales.
- It efficiently manages its receivables through timely invoicing and follow-up on overdue payments.
- Its payables are well-managed, with clear payment terms and good relationships with suppliers.
As a result, Company A consistently generates positive cash flow, allowing it to invest in growth opportunities and maintain financial stability. Most of the big companies you see making the news have positive cash flow, including Microsoft, Alphabet, Apple, Meta, and more.
Scenario 2: Negative Cash Flow
Company B experiences a seasonal downturn in sales, leading to reduced revenue. At the same time:
- Its payables remain high due to fixed costs and contractual obligations.
- It struggles to collect payments from customers, leading to a significant increase in receivables.
Because of these challenges, it faces a negative cash flow situation, making it difficult to cover expenses and meet financial obligations.
Scenario 3: Cash Flow Crisis
Company C experiences rapid growth, leading to increased sales volume and revenue. Sounds good… but it isn’t all sunshine and rainbows.
- Cash flow management processes lag behind, resulting in delayed invoicing and poor credit control.
- Despite great sales, Company C also faces a cash flow crisis, with inadequate cash reserves to cover expenses and fulfill orders.
In this kind of scenario, the business would be forced to seek external financing like business loans or make drastic cost-cutting measures to survive. Unfortunate, but all too common.
Common Cash Flow Management Issues
Cash flow management is essential but, unfortunately, some of the issues that come up seem nearly universal. Here are some of the most common issues business owners run into in their cash flow management:
Inaccurate Projections
Many businesses struggle with accurately forecasting their cash flow, leading to unexpected cash flow gaps or surpluses. While surpluses are obviously better to have, idle cash still represents a wasted opportunity to grow your business.
To address this issue, maintain accurate cash flow statements, track historical cash flow patterns, and use forecasting tools to predict future cash outflows and inflows.
Late Payments from Customers
Slow-paying customers can significantly impact your cash flow. To address this issue, establish clear payment terms, send timely reminders, and implement a systematic credit control process.
Another option is to use advanced payments, similar to a retainer, as 47% of small business owners do. This allows you to charge customers for services in advance, giving you ample cash to use as needed.
High Accounts Payable
A high level of outstanding payables coming due at the same time can significantly strain your cash flow.
It’s important to negotiate favorable payment terms with suppliers, explore early payment discounts, and streamline your procurement and payment processes. Building strong relationships with suppliers can also help in negotiating extended payment terms when needed.
Seasonal Fluctuations
Unfortunate, but it happens—many businesses experience seasonal fluctuations in sales and cash flow, regardless of the business model.
To manage this issue, it's crucial to plan, develop financial management skills and budget accordingly, identify your peak and off-peak seasons, consider adjusting staffing levels and inventory management, and explore alternative revenue streams during slower periods.
Categories of Cash Flow
When managing your cash flow, it's important to understand the different categories of cash flow. This will help you analyze your financial activities, identify areas for cash flow improvement, and increase your options.
1. Operating Cash Flow
Operating cash flow is the cash generated or used in day-to-day business operations. It includes:
- Revenue from sales
- Cash paid to suppliers
- Payments to employees
- Other day-to-day business expenses
2. Investing Cash Flow
Investing cash flow involves the money being used to invest in assets, as well as the return you’re getting from them. It includes:
- Equipment
- Property
- Other long-term investments
- Cash received from the sale of these assets
3. Financing Cash Flow
Financing cash flow represents the cash obtained through—or used to repay—financing activities, including:
- Loans
- Equity investments
- Dividends
- Cash received from issuing stock
- Cash paid to repay debts or distribute dividends
Cash Flow Management Best Practices
Now that you understand the importance of cash flow management and the various factors that can impact it, you can use these tips to get started:
1. Establish Clear Financial Goals
You can’t plan if you don’t know what you’re planning for.
Setting clear goals provides a roadmap for your cash flow management strategy, so you need to start by defining your financial objectives. If you’re new to accounting, this may seem challenging, but it will help you improve your profitability, reduce expenses, and increase cash reserves to keep your business running smoothly.
2. Monitor and Track Cash Flow
Implement systems and tools to monitor and track your cash flow regularly. This could include using accounting software, cash flow forecasting tools, or even simple spreadsheets.
Honestly, it’s a myth that cash flow management software or tools are pricey. Most cash flow tools are available through a software-as-a-service (SaaS) model, making it easy to get started with them (and switch it up if they aren’t working for you).
3. Analyze Cash Flow Patterns
Identify patterns and trends in your cash flow. Look for seasonal fluctuations, payment delays, or any other working capital trends that may impact it. This cash flow analysis will help you anticipate potential issues and take proactive measures to avoid or mitigate them.
4. Improve the A/R & A/P Processese
You can streamline your accounts receivable and invoicing process to ensure timely billing and prompt follow-up on overdue payments. Implement credit control measures, such as credit checks, payment reminders, and incentives for early payments and consider offering multiple payment options, to make it easier for customers to pay. It seems simple, but it works really well.
Where you owe money, you can:
- Negotiate favorable payment terms with your suppliers and vendors
- Explore early payment discounts or extended payment terms when appropriate
- Streamline your procurement process to ensure timely payments and avoid unnecessary late fees
6. Keep Cash Reserves
Set aside a portion of your revenue as a cash reserve; I know, I know, I said idle cash is an opportunity wasted, but this is still a good idea.
A reserve is your safety net during challenging times and allows you to seize opportunities for growth when things are good. Aim to build a reserve that can cover at least three to six months of your operating expenses and any needed capital expenditures in the short term and long term.
More Cash Flow Management Resources
This was the basic overview of cash flow management; there’s a lot further you can go if you want to get better at managing your cash. If you want to learn more, check out these resources:
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