‘’Mirror Mirror on the wall…’’ Sounds familiar? Read on to find out how this has anything to do with cash flow management strategies.
Cash Flow Management is the Snow White of the epic tale, the lead protagonist of your business. Which is why it should be given that amount of importance as well.
Cue entry: Cash Flow Management Strategies!
“Turnover is vanity, profit/loss is reality, but cash is everything/king.”
Not to be a Debbie Downer but there are a number of reasons small businesses fail, year-on-year. It’s important to note that a gigantic 82% of small businesses fail due to poor cash flow management.
What can you do about it?
By the end of this blog, you will walk away with a fair idea of what cash flow management is and the different cash flow management strategies that you can employ for your small business.
You should read this blog
- If you are an emerging or a growing business owner,
- If you in any way work with cash flow in your job,
- If you’re struggling with the reason behind a lack in business growth,
- If any of the above made you curious.
What is Cash Flow Management?
Simply put, it’s the incoming and outgoing cash in your business.This happens in different ways ranging from:
- Loan repayment
- Operational costs
How is Cash Flow different from Revenue and Profit?
A common mistake business owners make is focusing solely on revenue generation and profits. These are merely a part of the entire cash flow cycle. They cannot give you an accurate picture of your business’ financial situation.
Poor cash flow management can heavily impact your finances. It can not only set you back a couple years but can contribute to your business shutting down altogether.
As the name suggests, cash ‘flow’ is the cash you pay and receive. The important thing to note is that there’s a cash flow entry only when the cash has actually been paid or received.
Revenue is the income generated from sales of your product/service. This can be accounted for as per invoices, even if the money hasn’t actually been credited in your bank account.
Profit is the revenue minus expenses. Again, as it is a portion of revenue, it acts the same way.
Your business might do brilliantly in sales for the month, thus showing a healthy profit. But if it’s the 25th of the month and the invoice is due for payment in the next month, you have to ensure that there is enough cash in the bank to keep your business afloat for the current month.
Only with cash flow management strategies can you make arrangements for a sufficient bank balance at all times.
Negative and Positive Cash Flow
This one’s pretty straightforward.
A negative cash flow is when there is more cash going out of the business than coming in.
A positive cash flow is vice versa i.e. more cash incoming than outgoing.
Needless to say, your general aim is to maintain a positive cash flow at all times. This is a healthy business practice as it can help you weather a storm.
Ups and downs are inevitable in a business. In order to keep your business going through the lean periods, it is important to maintain a positive cash flow statement. This way, you have enough funds to take care of the payables and expenses until peak business periods.
While we’re on the topic, let’s discuss some of the reasons
Why your business can suffer a negative cash flow
Capital and operational investments are an integral part of the workings of your business. Machinery, administrative requirements, tools, packaging, etc. However, investing more than required can lead to significant cash getting blocked in the investments thereby hurting your cash flow.
It’s important to write down your investments and minimize it to essentials only.
It’s been six months. The business is running well, exceeding forecasts even. This is it – it’s the perfect time to make the most of this successful period and expand the business. Right?
This is a generic example but you get the gist of it. Depending on the nature of your business, expansion can and should be a part of the business plan. This can prove to be detrimental to your cash flow when you end up spending too much too soon on expansion plans. This blows it out of proportion and suddenly you’re left with additional expenditure and deficit cash to pay for it.
Another form of outgoing cash; overheads incurred by the business. Business overheads can be classified as recurring expenses namely rent, salaries, utility bills, etc. Often, as business owners, you might have an oversight with overheads as it is more of an administrative task.
Make sure to design a budget for the overheads depending on your cash flow. You should know where and how much cash is being spent. This way, you can minimize some of the overheads that are deemed unnecessary. Alternatively, for the overheads that you can’t do without, you can come up with cheaper alternatives that don’t hurt your cash flow much.
Inventory management is tied with your cash flow management. The products that you decide to stock up on, the quantity and the method of stocking up, all of these aspects combined have an impact on your cash flow.
How is that?
There are always some products that sell more, public favorites that are your best sellers. On the flipside, there are products that don’t perform as well. In this case, it’s important that you keep track of each of the products and their performance. Accordingly, stock less of the low performing products so as to avoid holding dead stock. Rather use that cash towards stocking up on best selling products. This way, you can save up on unnecessary outgoing cash and maintain a healthy/positive cash flow statement.
Setting up a business plan before you start the process is step 1 for any type of business. Similarly, drawing a financial plan for your business is a part of the process. Poor financial planning can lead to a negative cash flow. Running out of funds to pay creditors is a popular example for poor financial planning.
This one specifically is a sore spot that a lot of small businesses suffer with. Not getting your payments as per agreed upon terms results in overdue invoices. As the money has not yet been received, it cannot be accounted for in your cash flow statement, thus contributing toward a negative cash flow.
Now that we have understood the situation (Cash flow management) and identified possible reasons for a negative cash flow balance, it’s time to develop an effective action plan for the same. We are going to discuss cash flow management strategies that can be executed by you in order to solve the problem
Early Payments? Yes Please!
Who doesn’t love receiving early payments? That’s right. Nobody.
On the other hand, who loves making early payments? Oops.
This strategy, among other cash flow management strategies, might sound tricky but bear with us because it’s worth it!
You may have clocked the profits but if the cash isn’t credited in your account, it’s not going to prove useful. It’s natural to delay payments as much as one can, as a debtor. Thus, there have to be extra measures in place over and above invoicing your debtors, measures that incentivize them to make early payments. This way, you can account for the invoices upon payment and it’ll reflect in a positive cash flow statement. These measures can be one among the following ways to
Rewarding early payments
- Offer/Discount – Our brain is conditioned to be attracted by offers/discounts. Pair your invoices with a reward prospect for early payments. For example – Giving customers a 2% discount if the invoice is paid within ten days.
- Advance Payments – Ask your clients for advance payments. This one can be tricky to execute but it’s an industry best practice across all industries. By getting advances, you can account for the invoice in your cash flow statement on the same date which tallies with your P&L statement.
- Automated Reminders – Your clients have a ton of things on their plate. Especially if it’s a B2B transaction, your client has about as much work as you do, running the business ship. In such cases, they tend to forget payment dates. Sending them automated reminders for the same helps smooth the process on both ends.
- Simplify Payments – Give your clients easy and multiple ways of making payments. They don’t need it to be a cumbersome task to pay you, simplify it as much as you can.
- Avoid Cheques – Avoid receiving cheques as they mostly result in late payments.
Employ Invoice Financing and Factoring
What is Invoice Financing?
When your pending invoices are financed by a bank earlier than your credit period with the customer, it is invoice financing. The usual practice involves the bank or lending party to finance 80-85% of the invoice amount upfront. The remaining is financed when the customer pays the full amount, after subtracting a certain amount of financial fee for the transaction.
What is Invoice Factoring?
There are companies that take up all your pending invoices and pay you the amounts for it upon presenting the invoices. They proceed to take charge of receiving the money from the customers. A commission is charged by factoring companies for these transactions. Usually, bigger companies that don’t want to bother too much with chasing payments hire factoring companies to carry the operations out for them.
The biggest benefit involved in choosing either of the above options is that it ensures a positive and healthy cash flow statement.
Some other pros and cons that come with choosing this cash flow management strategy:
- You can extend the privilege of credit to your clients knowing that it won’t affect your cash flow.
- You can expect payments as soon as the invoices are raised.
- As is with any other form of third party financing, your borrowing limit increases as your business and related numbers grow.
- This process doesn’t require any collateral security.
- As the financial institution/factoring company is providing a service, there’s a fee attached to the same.
- In the case of factoring companies, they have taken the task of collecting outstanding payments from your customers; however there is only so much they will do for the same. The ultimate responsibility of unpaid invoices falls on your business.
Periodic Cash Flow Analysis
Preparing a cash flow statement is step 1. What’s really going to help you ensure it’s a positive cash flow is analysis of the statement. Analysing the statement uncovers weak points in your cash flow cycle that need to be improved.
Cash flow analysis is the medical equivalent of a check up by your general physician. It ensures that everything is functioning smoothly and gives you an insight into areas that require improvement.
Why should this be done periodically? You should be able to assess the state of your cash flow at any given time. This way, you can foresee any potential roadblocks and work on it. It also helps in staying on top of things like due dates for payables and receivables. Based on the analysis, you can structure your dates in such a way that it helps you maintain a positive cash flow statement at all times.
Get a Business Credit Card
Running a small business can result in some tight situations, money wise. Starting out and establishing your business, you might not always have enough cash to keep it afloat. In such cases, it can prove highly useful to have a business credit card.
Some of the benefits of owning a business credit card are:
- It works as a line of credit for your business.
- It makes up for any lapses in incoming cash flow.
- It provides you with temporary relief and helps you keep up with payments.
- Business credit cards like personal ones come with perks and rewards including travel based perks.
- You can streamline all business related payments by using this card to pay for it.
- Most credit card companies have incorporated a feature that helps input the credit card transactions into accounting softwares that you use for your business.
- These companies usually provide for employee credit cards as well that are tied to the same account.
Emergency Cash Reserve
It’s always a plus to save for rainy days, personally and professionally.
Even more so, with the volatile nature of small businesses, keeping aside an emergency cash reserve is a healthy practice. As previously mentioned, every business has its ups and downs. And you should be prepared to keep the business afloat during tough times. Tapping into a cash reserve kept aside for the exact reason can be the difference between staying in business and shutting down.
Cash flow management is about handling a business’s monetary needs effectively without affecting the operations. Months affected by low sales figures cannot be used as justification for a halt in regular business operations. Your recurring expenses have to be paid for regardless of the profit figures for that month.
An emergency cash reserve not only helps with honouringhonoring business payments, it also contributes towards a positive and healthy cash flow. And that in itself is a sure shot way of knowing your business will survive the lean period.
Cash Flow Forecasting
While a cash flow analysis helps you determine the present state of your cash flow, cash flow forecasting helps with estimations of your cash flow. It’s the equivalent of a weather forecast and it helps you predetermine your future cash flow position based on current business trends.
Like every other aspect of planning, forecasting helps you as a small business owner. It gives you an edge and allows you to stay one step ahead of your business operations. Based on how your business has performed, you can make a calculated estimate of your future cash flow statement.
A basic outline of the process of cash flow forecasting is:
- Forecast income generated from sales i.e. revenue.
- Forecast other means of inflow of cash.
- Forecast cash outflows of all types.
- Compile all of the above together to create your cash flow forecast.
- Compare this data against actual data available at present.
- Lastly, make the necessary decisions that help ensure a positive cash flow statement in the future.
Among other things
Growing profit margins
This is a natural step in the business growth plan. What’s interesting to note is that it very positively impacts your cash flow statement as well.
Upon establishing your product/service and gaining thought leadership in the field, backed by client trust and loyalty, your next step is increasing profit margins. You have proven you’re the better option to go with for the particular product/service you offer. In light of this, your growth plan will be activated. This involves increasing the profit margin.
What is the profit margin? The difference between the cost of you making/acquiring a product and the selling price to the end customer is your profit margin.
- Work on lowering the cost of making/acquiring the product.
- Increase the selling price of the product. (Make sure to watch out for competitor pricing, you don’t want to increase it exorbitantly and lose customers as a result.)
The above are two methods of increasing your profit margins.
Cut down on expenses
If you cut down on expenses, you are reducing your cash outflow which automatically lends to a bigger remainder of cash from your inflow.
Some of the ways in which you can cut down on expenses include but aren’t limited to:
- Cutting off any unnecessary overheads that you are currently incurring.
- Outsourcing of any departmental activities so as to avoid hiring a full time employee instead.
The above and many more cost cutting avenues are mentioned in a detailed manner here.
Summing it up, we hope you have a good grasp on cash flow management strategies; what it is, how important it is and how they can be employed in order to arrive at a positive cash flow statement.
Speaking about cutting down on expenses, it’s important to note some expenses that are necessary and need to be budgeted for. One of them being digital marketing, we at Profitcast look forward to hearing from you about your business’ digital marketing requirements.