Introduction
Cash flow management is key to handling company finances. Proper cash flow management ensures that your business brings in sufficient income relative to its spending. This process will also help you make use of your current finances as efficiently as possible.
What Is Cash Flow Management?
Cash flow management involves monitoring your company’s cash flow — a term that refers to the net balance of money that moves in and out of your business over time.
Funds that your company brings in through revenue, operation, investments, and financing are referred to as inflows. Meanwhile, funds that move out of your company through spending, debts, liabilities, and operating costs are referred to as outflows.
If your business reports a positive cash flow, this means that your company is experiencing greater inflows than outflows. On the other hand, if your company reports a negative cash flow, this means that your company is experiencing greater outflows than inflows.
Why Is Cash Flow Management Important?
Managing cash flow involves monitoring inflows and outflows and ensuring that the overall amount is positive. This is key to ensuring that your business maintains financial stability.
Cash flow management is important because proper oversight will allow you to make informed decisions in every area of business. For example, cash flow management will allow you to budget money for staff salaries, marketing and advertising, company expansions, the creation of new products, and any other activities that could require financial commitment.
In addition to managing your company’s current cash flow, it’s also important to look ahead and create cash flow projections for the future. It is possible to create a cash flow projection for any amount of time — whether that timespan is days, weeks, or years.
Newly launched businesses with little data on hand may find it challenging to produce long-term forecasts. As such, new firms may instead aim for short-term projections.
Types of Cash Flow
Cash flow can be classified in a few different ways. We’ll look at three types below.
Cash Flow from Operations (CFO)
Cash flow from operations (CFO) concerns monetary flows related to business operations. Inflows in this category come from cash that you receive as payment for products and services, plus interest income, dividends received, and other sources of funds.
Outflows in this category include money spent to produce goods and services, cash paid to vendors and suppliers, employee salaries, and taxes and interest paid.
Cash Flow from Investing (CFI)
Cash flow from investing (CFI) involves investments made by your company. This category includes operational investments and financial investments alike.
Inflows in this category include the sale of fixed assets, the sale of investment securities, and the collection of loans and insurance proceeds.
Outflows in this category include the purchase of fixed assets such as property or equipment, the purchase of investment assets like stocks and securities, and money lent by your firm.
Cash Flow from Financing (CFF)
Cash flow from financing (CFF) involves transactions between your company and its owners, creditors, and investors — all of which contribute to company financing.
At a more technical level, this category involves cash flows related to debt, equity, and dividends. Companies can take on debt by issuing bonds or taking a loan from the bank, or they can generate equity by issuing company shares. Companies can also make dividend payments to shareholders, representing the cost of equity for the business.
Positive flows can occur if you issue and sell equity or stock or bonds, or if you borrow debt. Negative flows may result from stock repurchases, dividends, and paying down debt.
Cash Flow Management Strategies
There are various strategies and tactics for effective cash flow management, all of which will give you a greater degree of financial control over your company.
Streamline Inflows Involving Payment
You can improve cash inflows by creating a streamlined payment process that incentivizes fast payments. This will increase the likelihood that customers make payments on time.
It’s important to provide customers with their preferred payment method. Retail customers may need to pay via card, by mobile payment, or through a specific payment network. Meanwhile, corporate customers and business partners may need to pay via invoicing systems.
If you issue invoices with a due date, you may want to offer discounts that encourage early payments. This is possible with net payment terms: for example, “5/10 net 30” means that payment is due within 30 days with a 5% discount if payment is made within 10 days.
You can also impose late fees to discourage missed payments. Furthermore, you can use credit control to determine whether your customers are likely to make payments on time.
Pay Bills Strategically and Optimize Expenses
You can optimize outflows related to expenses by paying bills in a strategic manner.
By paying your company’s most important costs first — such as employee salaries, rent, and utility costs — you can pay other bills on a staggered schedule. While you should generally avoid paying bills late, some bills have less urgent payment requirements or different due dates. Taking advantage of this can reduce the impact that outflows have on inflows.
You can also reduce expenses by finding the most affordable services overall — not just in terms of billing structure but also in terms of fees and other costs.
Maintain a Spreadsheet
By maintaining a cash flow spreadsheet and updating it consistently, you can closely monitor your inflows and outflows. This will help you optimize your cash flow balance. You can hire a financial expert to manage the spreadsheet or outsource the task to a professional.
Make Conservative Predictions
Cash flows should be monitored closely, but your predictions are unlikely to be fully accurate. For this reason, you should make conservative predictions. That means you should underestimate your company’s future income and overestimate its future spending.
This approach will give you some room for error in the event that your business underperforms expectations or faces a spending emergency.
Consider Financing Options
If you simply are not bringing in enough money, you can consider alternate financing options. This might include debt financing, equity financing, and credit and loans.
However, these financing options should not be used indiscriminately. You should also consider how these options will impact your company’s finances in the long term — including but not limited to the need to repay interest on loans and credit.
Examples of Cash Flow Management
Below, we’ll look at two examples of how a company might manage opposite financial situations. In the first, we will consider a shortage of cash, and in the second, surplus cash.
Cash Shortage
Imagine that your company needs to pay its suppliers in 30 days. However, you cannot afford to do so until you receive customer payments, which are due in 90 days.
In this case, your company can hasten payments by re-negotiating terms with customers, can make changes to its cash flow or financing strategies, or can obtain a loan or credit.
Any emergency strategy may avoid a deficit and allow for continued operations. However, each strategy might have a long-term impact on cash flow. If your company has accurately monitored its past cash flows, it will be easier to make an informed decision about the best solution.
Extra Cash
Imagine that your company has a surplus of cash after taking into account outgoing payments and outflows, and after taking into account discounts on incoming payments.
In this case, your company can pursue new investments and growth opportunities with its excess cash. With an accurate cash flow spreadsheet and forecast, you will be able to easily tell how much excess cash your company can afford to spend on its desired growth strategies.
Issues Affecting Cash Flow Management
Your company might face various issues in cash flow management, which will in turn reduce inflows or maximize outflows. Consider the following potential complications:
Cyclical Industries
Some sectors, such as real estate and the durable goods industry, experience cyclical trends. These industries expand during economy-wide improvements and contract during economic downturns. Naturally, these trends will directly impact your company’s cash flows.
On a smaller scale, some businesses and sectors simply experience off-seasons, meaning that your company may experience lower cash flows at certain times of the year.
You can address these issues by planning cash flows to the extent that it is possible to do so — and by using the strategies described elsewhere in this article.
Rapid Growth
You might assume that if your company experiences rapid growth, it will become financially stronger. However, this isn’t necessarily the case. Following growth, you might also pay greater employee, equipment, and operational costs, which can offset increased revenue.
As such, when you are recording and projecting your company’s cash flows, you should account for expected outflows alongside any increased inflows.
Failure to Collect Payments
Unless your business is properly set up to collect payments from its customers and clients, you will almost certainly see lower cash flows than expected.
If your firm collects payments via invoice, be sure to create an organized accounts receivable system to collect all payments from your customers. Doing so will help you keep track of and collect payments from customers by the proper due date.
If your company handles retail payments, be sure to support payment types required by customers, such as card-based payments, mobile payments, and other transaction types.
Delayed Payments from Customers
Your company might experience delayed payments from customers, thereby limiting inflows. Fortunately, there are various ways to encourage on-time payments.
By offering incentives such as discounted early payments, and by imposing penalties such as late fees, you can motivate customers to pay promptly.
You might also choose to extend credit to customers or extend payment terms. If your company can afford this, it is a great way to build trust with, attract, and retain customers. However, this strategy might become unaffordable if your customers abuse this offer.
No matter how you approach the issue, eliminating delays entirely may be impossible. In that case, you can only account for late or missed payments in your records and projections.
Poor Expense Projections
You should ensure that your expense projections are accurate. By creating accurate predictions based on past financial information, your company will have a greater ability to afford expenses in the future. This is true regardless of whether those costs are expected or unexpected.
If you simply do not have enough data to make precise predictions, you can make conservative predictions, once again providing some degree of protection against emergency costs.
Boosting Cash Flow Management
There are various approaches to boosting cash flow, most of which involve closely monitoring and working with your company’s finances. Consider these strategies:
- Budgeting: Creating a budget involves forecasting your business’ spending and earnings, allowing you to balance your inflows and outflows
- Cash flow analysis: Distinct from budgeting, creating a cash flow analysis involves outlining scenarios and predicting possible high-risk circumstances; this will allow your company to prepare for difficult financial situations in advance
- Recordkeeping and spending reviews: Whereas budgets and cash flow analyses can help your company predict its future outcomes, recordkeeping and spending reviews will allow your company to keep track of its past cash flow data
Balancing cash flow through those methods will help maximize inflows and minimize outflows, thereby boosting your company’s cash flow overall.
Specific Strategies for Boosting Cash Flow
You might pursue more specific approaches for boosting cash flow. Consider these strategies.
- Increase revenue: Increasing your company’s revenue is the simplest way to improve inflows, assuming that you are in a position to accomplish this
- Reduce expenses: Your company should look for the most cost-effective options in all areas of business — especially in areas where cash outflows are high
- Pursue sustained growth: Rapid growth can come with extra costs; accordingly, you should aim for sustained long-term growth rather than short-term growth
- Collect payments on time: Your company should encourage timely payments; to do so, you can offer discounts for early payments and impose late fees on missed payments
- Use credit and loans effectively: It might be necessary to obtain credit or loans when your company makes large purchases; however, you might need to pay interest on these sources of financing, so be sure to consider the pros and cons of this strategy
- Delay outflows: You can minimize the effect of outflows by staggering expense-related transactions, insofar as payment terms allow you to do so
- Use financial professionals: You can rely on an accountant, financial advisor, or banking services to provide advice about cash flow management
- Use technology: Financial tools like accounting software, forecasting software, spreadsheet software, and tax software can help you manage cash flow
- Find business partners: By maintaining a close relationship with suppliers, lenders, and clients, you will be able to obtain agreements that benefit you; those partners are also likely to submit payments on time if you maintain a close relationship
- Diversify revenue streams: You should offer a wide range of products and services to ensure that your business remains operable across changing circumstances
Conclusion
Cash flow management is vital because it allows your company to balance its spending and income — and, by extension, continue its regular business operations.
Optimizing cash flow requires strategies that increase inflows and reduce outflows. This involves ensuring that your business receives payments on time and minimizes its spending. It also involves adjusting financial, investment, and operational activities that impact cash flow. Hiring a financial professional can help you handle all of these aspects of cash flow management.
Finally, it’s important to monitor and forecast cash flow. This can help you address difficult financial situations and make the most of funds when you are at a financial advantage.
