Cash Flow Management: Know the Flow
by Brandon Salesberry, on Mar 20, 2018
If accounting is a science, cash flow management is more of an art. And it’s an art that requires you, as a business owner or CEO, to learn its fundamental components, then assess how to apply them to your unique situation. Every company has different priorities and different cash needs.
Cash is the lifeblood of any business. Without it, you couldn’t pay your employees, suppliers, and other obligations, let alone make investments in your company’s growth.
And yet, a surprising number of companies, especially small ones and start-ups, do not have a firm grasp on the amount of cash coming in and going out, and why.
Good cash management begins with good books
Getting on top of your cash situation begins with good accounting and bookkeeping systems. When we work with clients that are having cash flow issues, usually their accounting systems are not giving them the specifics they need to tackle the problems head-on. And because they don’t know how much money is coming in and going out, cash-flow crises usually take them by surprise—especially if they think they’re turning a profit.
There are many good software options available for accounting and tracking your cash flow. You also need to make sure that company data is being entered in a timely and accurate fashion—either by a well-trained and reliable bookkeeper (who might be a part-time employee at smaller companies), or by an outsourced financial firm like Paro, whose experts can set up accounting and cash-flow-management systems that you can rely on going forward.
The money comes, the money goes
Simply put, cash flow (not the same as profit or loss) is the movement of funds in and out of your business. Positive cash flow occurs when the cash coming in to your business from sales, accounts receivable, etc., exceeds the amount leaving your businesses through salaries, rent, supplier payments, loan payments, and other accounts payable. Negative cash flow is the opposite: your outflow of cash is greater than your incoming cash.
Generally speaking, positive cash flow is good news; while negative cash flow, besides potentially creating short-term payment problems (depending on your reserves, which we’ll get to in a bit), also might signal that your business is in trouble and that you need to take steps to generate more sales and/or reduce expenses. Negative cash flow can also occur during a period of growth when you are investing in your business to make it stronger and more competitive; that’s fine as long you have a handle on what’s happening.
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Ask and you shall receive? It’s not that simple.
Managing accounts receivable is an important component of the art of cash flow. If you stay on top of collections and keep clients paying in a timely fashion, you’ll have more cash in the bank, and more options on how to use that cash. Start by reviewing your policies; for example, do you automatically offer terms, say, at net-30? Consider other options, including asking for payment on receipt, offering prepayment discounts or subscriptions, or requiring 50 percent down.
Use software programs and applications that can automate a lot of this and set up reminders to increase the rate of collections. And pay attention to customers’ preferences on how to pay. If customers seem to have trouble writing and sending checks, switch them to credit cards or online payment systems. It is worth a minimal fee to actually collect the payments.
Unless your business is a bricks-and-mortar retail shop where customers pay for the goods before they leave the store, or an online business where a sale cannot be completed without payment, chances are you offer terms to many of your customers. If you have salespeople in the field generating new business, remember that they may me more interested in completing the sale than collecting the money. Train them with firm guidelines on how to establish a payment relationship with new clients before receivables get out of hand.
Despite your best efforts, you probably will have a handful customers who fall behind in payment. If you have good systems in place, you can spot the bad eggs and cut them off, but now your collection options are reduced. You can refer them to an agency; you can offer to negotiate a settlement. You don’t want customers like this, which is one of the reasons you need good cash-flow analysis.
The other side of the coin is how quickly you pay your bills. And if you are paying them faster than you’re collecting your receivables, that will negatively impact your cash flow. So again, part of the art of cash-flow management is finding ways to slow down payables.
Some of your expenses have to be paid on time: rent, utilities, payroll, taxes, and anything else specific to your industry that is non-negotiable. After these, there is flexibility.
Ideally, you want to negotiate the best payment terms you can with each vendor, to the point where your payables and receivables are in balance. And every vendor is different when it comes to terms, credit limits, etc. It is important to establish and maintain good relationships, which will ease your negotiations in the future. As one example, if you have to hold off on a payment, call the vendor and be up-front about the delay, and offer a reasonable time frame to pay up. If you make good on that, it will build trust.
But the typical expenses and payables for your business aren’t your only cash outflows (this is where relying just on your net profit or loss can get you in trouble). Every month you may have loan payments due, distributions or dividend payments, or other non-P&L cash outflows; not to mention other larger cash needs for repairs, extra inventory, investment, etc. Don’t forget about these cash needs as well when developing a cash-flow management plan. In the long run, getting your cash flow under control will put you in a better cash position and reduce the need to finagle.
Surprises happen—be ready for them
Now, let’s say you have good analytics, you know your cash flow, and you have receivables and payables under control … and BAM. You’re hit with a sudden need for cash: a broad economic downturn, a seasonal slump, or an unexpected need for repairs or new equipment.
Again, this is where the art of cash-flow management comes in. When business is booming, and you have positive cash flow for a long enough period of time, if you manage it well, you’ll have a healthy cash reserve on hand to take care of an emergency.
If not, you may have to try to lure new investment or secure a bank loan. And part of the art of navigating cash flow is to have solid relationships with potential investors and/or financial institutions before the unforeseen need arises. If you don’t, you may be out of luck if your financials look stressed and you are cold-calling financial institutions for desperate help. Good prior connections with lenders who like you and understand your business will go a long way toward smoothing the process of approval.
How much of a cash cushion should you have ideally? Certain industries, like insurance, have legal requirements for cash reserves to pay out premiums as claims arise. In the nonprofit world, you need the equivalent of three to six months’ operating costs on hand in case donations dry up. Or take an industry like food service, where reserves are not mandated, but margins are so paper-thin that it takes longer to build up a cushion, which can be wiped out much faster. So every cash-flow decision has a lot of impact.
Two of the most obvious ways to improve cash flow are to increase revenues through sales of your products or services, and to reduce expenses. Less obvious to some (especially new) business owners caught up in the day-to-day is that any extra cash on hand can be put to work earning interest (avoid long-term instruments that lock up cash you might need sooner than you can get at it). And if you can artfully keep more of your cash on hand—say, holding off a week or two on paying vendors—you can keep that cash earning interest longer.
Mastering the art of cash-flow management means learning how to plan and prioritize. It’s a lot like personal finance: anticipating when you’re going to have extra cash and deciding what’s more important to do first: Taking a vacation, putting on a new roof, or beefing up the college fund. In business, know your seasonal fluctuations, develop tools to project sales, and build up cash, so that you can plan investments and projects accordingly—and be ready for the inevitable surprises.
Brandon Salesberry has served numerous organizations as a financial and operations manager in a full-time role (most recently for Organizing for Action, a grassroots and issue advocacy organization based in Chicago), but now serves multiple organizations as a part-time CFO/COO through his firm, the Salesberry Group. He has more than 12 years of experience at all levels of operations, finance, administration, facility, IT, and volunteer management. Outside of the Salesberry Group, Brandon spends his time running, working on home renovation projects, and spending time with his family. He lives in the Hyde Park neighborhood of Chicago with his wife and 2 children.