Cash flow management is one of the foundational elements of your business's financial picture. It involves knowing when your cash is coming in and managing your spending to your available cash. Revenue is the money that comes into your business, while cash flow management measures how much is coming in and going out.
With the cash accounting method, your books will align with the amount of cash you have readily available. However, your cash flow management is even more critical if you use the accrual accounting method.
With the accrual accounting method, revenue is entered into your books when an invoice is generated, but the cash is not available until the customer pays the invoice. It is essential to understand which method you use and how it impacts your cash flow management.
Here are five tips:
There are three areas of cash flow coming into your business:
Operational cash is just what it sounds like – the cash generated from business revenue, sales of inventory, assets, etc. Cash from financing is what you receive from lenders for short-term and long-term financing. Cash from investments reflects the gains and losses of your investments, including buying or selling equipment.
When analyzing your cash flow, you should delve into positive and negative cash flow scenarios:
Positive Cash Flow: This is an indicator of your company's health and sustainability in growing its operations. Too much cash may mean you aren't investing enough back into the business. You may want to use excess cash to pay down debt, purchase equipment, or acquire another company.
Negative Cash Flow: This isn't always a bad indicator. If your business is spending cash to invest in property and equipment to help grow the business, negative cash flow can be a good thing. However, if you consistently have negative cash flow, you will need to make modifications to ensure you have enough cash to timely pay bills.
Generating cash flow statements and projections can be done with your accounting software. Talk with your accountant and, if needed, look for a new accounting system that will give you the timely reports you need to make informed decisions.
When exploring ways to increase revenue, ask yourself and your management team these four questions:
Generate a list of ideas and start implementing a few at a time. Monitor what works and adjust your strategy as you move through the year.
If you spend less on operations, you will have more cash left at the end of the month. Look at your vendors to see if you are getting the best pricing. Could you buy more at one time to get better prices? Are your processes efficient or are there ways to streamline to reduce costs?
Inventory management will ensure you have enough inventory to fill orders, but not so much that you have cash tied up for long periods. If you have excess inventory, consider a sale to free up cash. This is an area you should be continually reviewing with a particular focus on the seasonality of your products.
Aligning your accounts receivable to accounts payable will help you alleviate cash crunches at the end of the month. If your customers typically pay at the end of the month, ask your bank to align your loan payments at the end of the month versus mid-month. Incentivize customers to pay on time by charging a small interest fee if invoices are paid late.
Give customers 30 days to pay, instead of 60, to bring cash in faster. Offering credit card payments may help customers pay earlier. Give a percentage off if the invoices are paid in 10 days or less.
Pay off debts earlier when you have excess cash. Aligning extra payments during the times you have a higher sales volume will mean you have less to pay when cash flow may be lighter. Make sure you work with your financial institution on the best options so you don't incur penalties for prepayments.
Review your loan contracts and obligations with your accountant and financial institution to determine if better financing is available. Perhaps changing the terms of a loan or combining several loans will give you a better interest rate or a faster paydown of the principal.
As a last resort in a cash crunch, you may need to sell assets. Keep a list of assets no longer used, or those that you could liquidate if the need arises.
Cash flow is just one element of building a company that is prepared for the future. Work with an accountant who understands your industry to review your financial picture fully. Take an in-depth look at your financials and benefit from the expertise of an experienced advisor. You will be glad you did.