Imagine this scenario…your business has been growing quickly over the last 9 months but you are continuously having challenges paying your fixed expenses and payroll. You wonder how in the world this could happen when your sales have grown 100% in that same time frame. You’d be surprised to know this scenario is quite common in small businesses because the leadership team (or CEO/founder) does not have a good handle on the financial management of his/her company. Reality is, cash flows are king when it comes to the financial management of a growing company. The lag between the time you have to pay your suppliers and employees and the time you collect from your customers is the problem, and the solution is cash flow management.
Simple right, just look at your monthly profit and loss statement (P&L) and if its green we are good? Wrong. Profit does not equal cash flow. You can’t just look at your P&L and get an understanding on your cash flow. Many other financial figures feed into factoring your cash flow, including accounts receivable, inventory, accounts payable, capital expenditures, and debt service. Smart cash flow management requires a laser focus on each of these drivers of cash, in addition to your profit or loss.
What is cash flow management? It is a key aspect of financial management of a business, planning its future cash requirements to avoid a crisis of liquidity. Cash flow management is important because if a business runs out of cash and is not able to obtain new finance, it will be forced to close.
When should you be measuring cash flow in your business? You should prepare cash flow projections for the next year, next quarter and, if you’re on shaky ground, next week. An accurate cash flow projection can alert you to trouble well before it strikes.
How do you measure cash flows? Simply put, start your cash flow analysis by adding cash on hand at the beginning of the period with other cash to be received from various sources and when you believe they will be received. Next, have a detailed knowledge of amounts and dates of upcoming cash outlays. That means not only knowing when each penny will be spent, but on what. Have a line item on your projection for every significant outlay, including rent, inventory, salaries and wages, sales and other taxes withheld or payable, etc. These “ins” and “outs” will give you a great period projection for if you will be cash flow positive or negative. The important part of this practice is to have estimated dates for the “ins” and “outs” based on your experience with the customers, suppliers, and other stakeholders.
So how can you improve your cash flows?
- Know your “break-even” point because knowledge and goals in the financial management of the business is extremely important.
- Collect accounts receivable ASAP by giving your customers incentives to pay faster.
- Negotiate better payment terms with your suppliers so your cash outlays are in more beneficial timing patterns.
- Designate someone to analyze cash flows during the appropriate periods so you don’t lose focus on one of the most important parts of the management of your business.
- Use technologies like spreadsheets, dashboards, or accounting software to make sure you are keeping numbers at the front of your brain daily.
- Maintain cash reserves throughout the year because sales sometimes slip or large expenses come up out of nowhere.
Want some more “advanced strategies” for cash flow management? Use ratios. The below ones will all help you understand the liquidity of your business in different ways.
Current Ratio = Current assets/Current liabilities
Quick Ratio = (Cash + equivalents + accounts receivable)/Current liabilities
Operating Cash Flow Ratio = Cash Flow from operations/Current liabilities
Cash Flow Efficiency Ratio = Cash Flow from operations/Sales
How do you survive shortfalls? The key to managing cash shortfalls is to become aware of the problem as early and as accurately as possible. When the reason you are caught short is that you failed to plan, a banker/investor is not going to be very interested in helping you out. If a banker/investor won’t help, turn next to your suppliers. These people are more interested in keeping you going than a banker and you can often get extended terms from suppliers that amount to a hefty, low-cost loan. Finally, if that doesn’t work, you may be able to raise cash by selling and leasing back assets such as machinery, equipment, computers, phone systems and even office furniture. Leasing companies may be willing to perform the transactions but beware you could lose your assets but you won’t need them if you are out of business anyways!