In the world of business, cash flow is often described as the lifeblood of an organisation. However, effective business cash management separates the successful businesses from those that look great on paper but run into financial difficulties — or worse, fail completely. Knowing what cash flow is, why it is important, and how to control cash flow is the difference between success and a cash crisis.
What is Cash Flow?
Cash flow refers to the net amount of cash and cash equivalents being transferred in and out of a business. In other words, it measures incoming and outgoing cash, measuring cash inflows from sales, investments, and financing against cash outflows for operations, expenses, debt, and other obligations.
Cash flow, in general, can be divided into three broad types:
- Operational Cash Flow: Cash made from ordinary operations such as the sale of product, services, or production.
- Cash Flow from Investing: Cash used for cash received from investments, such as equipment purchases or the sale of a subsidiary
- Financing Cash Flow: This relates to cash from investors or loans or cash paid out to them, such as dividends, debt repayments, and issuance of equity.
Out of these, operational cash flow is the most critical, as it suggests if the business is capable of achieving enough cash inflow from its operations to stay alive without external money flowing in.
Why is Cash Flow Important?
A business can be well profitable but may also go bankrupt due to improper control of liquidity. A company could have high accounts receivable and good assets yet is unable to pay suppliers or make payroll because cash flows poorly from operations at that point in time. This cash flow problems can limit expansion, harm credit ratings, and make borrowing more expensive.
This is the importance of the cash flow:
Provides solvency: A healthy cash flow allows a company to meet its short-term liabilities.
Enables expansion: Cash allows you to invest funds into new ventures and activities such as sales, inventory, or equipment.
Access to liquidity: It is easier to weather unforeseen expenses or changes in the market if liquidity levels are strong.
Enhances Decision Making: Cash available in hand gives a clearer picture for making the right strategic decisions.
The Best Tips To Manage Cash Flow
Good cash management in business simply means knowing your money: where it comes from and where it goes, and how you can control it. Here are some practical approaches to controlling cash flow:
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Monitor Cash Flow Regularly
Forecast inflows and outflows with detailed cash flow statements. It will allow you to know, at any time, how much liquidity you are left with. Utilise tools from excel spreadsheets or accounting software to represent these data to have an idea of future needs.
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Speed Up Receivables
Prompt for quicker payments from clients. Incentivise early payments, bill your stuff right away, and follow up regularly. Using a digital payment method can minimise time delays which are caused by banks.
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Manage Payables Strategically
Avoid damaging relationships to take advantage of full payment terms with suppliers. Stretching payables is a great way to preserve cash but be careful not to avoid taking discounts or break the trust of suppliers.
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Maintain a Cash Reserve
It acts as a buffer for your material values which could help safeguard your business during tough economic events or unanticipated expenses.
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Reduce Overheads
Review operating expenses regularly and cut any unnecessary expenses. Reassess contracts, switch to cheaper suppliers and outsource functions if possible.
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Use a Cash Flow Forecast
You can then plan for shortfalls which is where cashflow forecasting steps in the picture. One of the more common ways is the 13-week cash flow model, which provides a view of cash flows in the short term. We make these predictions to prepare the businesses for both surge, and obstacles.
Cash Flow Strategies for Small Businesses
Minor cash disruptions spell doom for small or growing enterprises. Below are a few cash flow tips aimed at small business owners:
- Bill quickly and accurately: A streamlined process reduces billing errors and delays in payments.
- Don’t overstock: Excess inventory ties up unnecessary money.
- When to Lease Instead of Buy: Lease equipment or vehicles you need to keep upfront cash requirements down.
- Reassess pricing strategy: Ensure your prices are not only covering costs but also delivering on healthy margins.
- KPI Tracking: Keep DSO, current ratio, and other liquidity-focused metrics in check
The above cash flow tips for small business owners to help them develop good financial habits and avoid the most common traps that lead to a liquidity crisis.
The Use of Discounted Cash Flow in Management
Specifically, discounted cash flow (DCF) is a financial model that uses economic as well as physical data to forecast cash flows associated with a given investment or business over time, compared to traditional cash flow analysis which tends to focus on cash pay-in and pay-out flows. The DCF approach takes all of those future cash flows and discounts them back to today based on a discount rate which correlates with the risks or costs of capital.
There are a few ways discounted cash flow can help to improve how you manage the cash in and out of your business:
- Guided investment choices: Assess whether expansion plans, mergers or capital possible.
- Business valuation: Helpful in selling, acquiring, or fundraising processes.
- Strategic forecasts: Assist in projecting the long-term profit and viability.
Though less common in finance-light use cases, we highly recommend adding DCF to your cash planning as it yields a richer understanding of your financial position and capacity.
Keeping a Positive Cash Flow for the Long Run
Cash flow management is not a one-time exercise; it needs to be an exercise in discipline. These are additional tips on long-term cash flow that will help keep your business on solid ground:
- Automate when you can: Use accounting tools that automatically sync with the bank to track cash movement as it happens.
- Perform internal audits: Regular audits are needed to make sure there are no possible money leaks.
- Have a plan for taxes: Save money regularly so you do not run into cash flow crumple near tax deadline dates.
- Keep a good banking relationship: If you have a good relationship with your bank, it is easier to get lines of credit or loans when you are temporarily in need.
Regularly implementing these practices will help you smoothen cash flow and create a more stable financial position.
Cash Flow Management in Times of Economic Instability
Economic downfalls or inflation presents their own challenges as well. Demand from consumers could wane, expenses could increase, and funding could grow to become additional restrictive. In times like this, some defensive cash flow tactics to think about are:
- Improve credit terms: Execute more discretion while providing credit to customers.
- Restructure debt: Work with lenders to refinance or extend repayment periods.
- Scenario planning: Develop best-case, worst-case and most-likely cash flow projections as a proactive measure for potential outcomes.
Slashing discretionary spend: All discretionary initiatives will be put on hold until we stabilise in our business. Being proactive rather than reactive during uncertainty will keep you agile and bestowing resilience to your business.
Conclusion
Every business, whether in the start-up phase or having been around for decades, needs to understand what cash flow is and how to control it. Cash flow impacts every aspect of your operations, from daily operations to long-term planning. With appropriate cash flow strategies, using financial metrics such as discounted cash flow for long-term decision-making, and practical tips on cash flow, you can improve the cash management in your business significantly.
However, as your business grows, focusing on operational cash flow will help your business not only survive but thrive within the competition. Keep in mind, while profit may be the intention — unless they can pull cash from the bank, your business never crosses the finish line.
