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Managing cash flow is a critical aspect of entrepreneurship, whether your business brings in hundreds or millions in revenue.
Though cash flow management is an essential element of good business, the whole subject often eludes many solo entrepreneurs and professionals in upper management. In this post, we’ll take a closer look at what cash flow management is, why it’s essential, and some key considerations that business leaders should consider when managing their cash flow.
What is Cash Flow Management?
Cash flow management is the process of managing the movement of cash into and out of a business. It involves forecasting, budgeting, and monitoring a company's cash inflows and outflows, ensuring that the business has enough cash on hand to meet its financial obligations and avoid shortages that could interrupt its plans.
Effective cash flow management is crucial for the survival and growth of a business. Without proper cash flow management, a company may be unable to pay its bills or meet its financial obligations, leading to financial distress and even bankruptcy.
Though no business owner can see the future, those that take measures to ensure a positive cash flow will be better equipped to invest in growth opportunities, manage debts, and increase reserves for unforeseen crises.
Common Challenges in Cash Flow Management
On its surface, managing cash flow isn’t rocket science: you just have to ensure incoming revenue is higher than your outgoings. But unfortunately, outside influences and unforeseen challenges can make managing a business’s cash flow difficult.
Here are some common challenges that businesses face when managing cash flow:
Slow-paying Customers
When customers take longer to pay their invoices, it can cause a strain on the business's cash flow. Even with codified payment terms, customers and clients can find ways to drag their feet without violating your policies and causing a backlog. This is particularly problematic for businesses operating on thin margins or with a high volume of customer accounts.
Seasonal Fluctuations
Many businesses experience fluctuations in cash flow throughout the year due to seasonal trends. Whether it’s retailers with high cash flow during the holiday season or companies in the travel industry with a slump at the start of the school year, seasonal shifts are an essential consideration for almost any business.
Unexpected Expenses
Unexpected expenses, such as equipment breakdowns, emergency repairs, or sudden economic anomalies, can cause a significant strain on cash flow. Like slow-paying customers, this is particularly challenging for businesses operating on tight budgets or having limited reserves.
Difficulty Forecasting
Cash flow forecasting is an essential aspect of cash flow management, but it can be challenging to predict future cash inflows and outflows, especially in companies with complex, niche products or services. Additionally, factors such as economic shifts, customer behavior, and competitive pressures can make forecasting difficult.
Limited Access to Credit
Many businesses rely on credit to manage their cash flow, but their access to these credit sources can change at short notice for various reasons. This is a massive worry for small businesses and startups that are still developing their brand equity.
Misaligned Payment Terms
Misaligned payment terms between a business and its suppliers or customers can lead to cash flow difficulties. For example, if a business has to pay its suppliers before receiving payment from its customers, it can strain cash flow.
Lack of Proper Expense Management
The final but often most damaging challenge to cash flow management is a simple lack of control regarding the business’s expenses. This is common in fledgling startups where the founder and co-founder(s) are wearing many different hats and struggle to find the time and resources required to handle the operation’s various expenses. Investing in an expense management tool like Fyle can help you regain end-to-end control over your business expenses.
Suggested Reads: 5 Benefits of Using Cloud-Based Expense Management Software
How to Better Manage your Cash Flow
Now that we have a handle on why managing cash flow is essential and the obstacles that can arise, entrepreneurs should take some critical steps to manage their cash flow effectively.
Understand Your Cash Flow Cycle
The first step in managing cash flow is understanding the cash flow cycle of your business, essentially, the time it takes for a business to convert its investments into cash. This includes the time it takes to receive payment from customers, pay suppliers, and pay other expenses.
The typical cash flow cycle can be broken down into three main stages: cash inflow, cash outflow, and net cash flow:
Cash inflow is the money that comes into the business from sales, investments, and other sources.
Cash outflow is the money that goes out of the business, including expenses, taxes, and debt payments.
Net cash flow is the difference between cash inflow and cash outflow. A positive net cash flow indicates that the business has more money coming in than going out, while a negative net cash flow indicates the opposite.
Though cash flow cycles can be pretty nuanced due to different touchpoints and industry trends, getting well-acquainted with everything that makes your cash flow cycle happen will work wonders for your larger approach to management.
By studying your cash flow cycle, you’ll be better equipped to anticipate when cash shortages may occur and take steps to manage them.
Secure Efficient Payment Arrangements
After all parties have signed a deal, it's natural to feel a sense of accomplishment, but you’re not out of the woods yet!
Ensuring that payment is received on time is a crucial foundation for good cash flow management. If your accounts receivable (incoming cash) start to pile up due to payment delays, it can quickly push you into negative cash flow, even if your business appears profitable on paper.
To expedite payment, start by negotiating terms with your clients to set the payment deadline as soon as possible. You can also request a partial deposit upfront to generate immediate cash flow before issuing a final invoice.
If a client or customer is late on a payment, don’t waste time reaching out to remind them about the agreement. If your business is proliferating and you’re feeling a little overwhelmed by all your client accounts, consider using invoice management and accounting software to automate the process and accept electronic payments.
Provide Incentives and Penalties
One strategy to encourage clients to pay early is by offering them clear incentives.
These might include a set policy on outstanding payments, e.g., a two percent reduction on the invoice value if payment is made within seven days. Other incentives include discounts on future orders, redeemable loyalty points, or merchandise. Be sure to include these incentives in the invoice to motivate the client to take advantage of the offer.
You can also reduce the risk of unpaid invoices by implementing late payment fees. Clearly outline the late payment penalty in the initial customer contract and again when the invoice is issued, explaining the fee and when it applies.
Suggested Reads: 12 Tips to Master Invoice Accounting for Your Business
Review Your Accounts Payable Terms
As well as speeding up your accounts receivable process, consider taking the opposite approach for your accounts payable (outgoing cash).
Instead of immediately paying a bill as soon as it arrives, review the terms to see how long you can wait before making payment. This can help prevent a cash shortage and shouldn’t affect your relationship with any reasonable supplier.
Similarly, don’t be afraid to negotiate payment terms with vendors if they’re causing you trouble. Contact them and see if they would be willing to offer longer payment terms in exchange for your business. It’s also good to know if you qualify for early payment discounts to boost profit margins when your cash flow is strong.
Suggested Reads: 6 Ways Businesses Can Automate Their Accounts Payable Process
Reduce Unnecessary Spending
Business expenses can quickly add up and drain cash flow, and even if they seem insignificant, most businesses have some area where they’re letting capital slip away unnecessarily.
Suppose your outgoings are putting a strain on your business; set aside time to review your spending and find places where you can tighten your belt. This could include extra office space you don't use, unsold inventory, expensive but unnecessary tools, and countless other things.
By actively managing business expenses and cutting out unnecessary spending, you can help prevent cash leaks that can fly under anyone’s radar.
Suggested Reads: What is Spend Management, and Why is it Important for Businesses
Lease Instead of Buying Equipment
Business owners can often avoid high up-front costs of new equipment and other capital expenditures by leasing instead.
Leasing equipment for a fixed monthly fee will allow you to make smaller payments that don't eat into your essential cash reserves. Furthermore, it will mean you won’t have to worry about the higher cost of maintenance and replacement often carried by investing in large, expensive equipment.
Many commercial lease agreements include maintenance, so leasing may be a better option if you're spending a lot on technician fees.
Consider Invoice Factoring
Invoice factoring is a type of financing in which a business sells its unpaid invoices to a third party, called a factoring company, at a discounted rate to receive cash upfront.
The factoring company then collects payment from the customer. This can be a practical option for businesses with many unpaid invoices needing help with cash flow. It can also be useful for businesses that need help getting traditional financing because they are new or have poor credit.
Remember that invoice factoring can be expensive and should only be applied as a short-term solution. If it’s poorly managed, this approach to raising funds can cause more monetary issues than it fixes and undermine your ability to deliver a quality experience to your customers.
Suggested Reads: A Comprehensive Guide to Managing Cash Flow for Small Businesses
Final Thoughts
Taking your cash flow by the horns is daunting, especially if your business is growing rapidly and you’re having trouble managing its day-to-day operations. However, by taking a proactive approach, you’ll soon begin to enjoy positive knock-on effects on all facets of the company.
By understanding the cash flow cycle of your business, securing efficient payment arrangements, reducing unnecessary spending, and more, you can effectively manage your cash flow and ensure the continued financial stability of your venture.
