Managing cash flow effectively is essential for any business. It’s a day-to-day battle that occupies business owners and management's minds. Not only is it key to a company’s survival, it is also key to fueling growth and keeping the company adaptable in a fast-changing market. For businesses of all sizes, from startups to global corporations, effective cash flow management can be the deciding factor between thriving and struggling.
In this article, we’ll discuss practical strategies for effective cash flow management, helping business owners strengthen their financial position and achieve better results.
What is Cash Flow?
My co-founder often quotes an old saying “Revenue is vanity, profit is sanity, cash is king”. This begs the question “What is Cash Flow”? Cash flow is simply the movement of money in and out of a company over a specific time period. A cash flow statement typically breaks down this movement into three categories:
1. Cash flow from operations – This is the money generated, spent, or lost by the company’s core business activities.
2. Cash flow from investments – This refers to money flowing in or out due to buying or selling long-term assets like property, buildings, or equipment.
3. Cash flow from financing – This includes funds raised or used to repay investors and debt providers (creditors).
Some also consider a fourth type of cash flow: free cash flow. This represents the cash remaining after covering operational and capital expenses. It differs from net cash flow, which is the combined total of the three main categories listed on the cash flow statement.
Example:
To understand this better, imagine a small business called “Green Gardens” that sells plants and gardening supplies. Here’s how each type of cash flow might look for them for this month:
- Cash flow from operations – Green Gardens collects $5,000 from sales and spends $2,000 on supplies, rent, and wages, leaving an operating cash inflow of $3,000.
- Cash flow from investments – The business buys a new delivery truck for $10,000. This is a cash outflow related to investment.
- Cash flow from financing – To help with the truck purchase, Green Gardens takes out a $8,000 loan. This loan adds a $8,000 financing cash inflow.
Net Cash Flow: The business has a net cash inflow of $1,000. If they had a starting cash balance of $10,000, they now have $11,000 remaining as a result of the cash flows this month.
These categories help Green Gardens track where cash is coming from and where it’s going, giving a clear view of their financial health.
Understanding Cash Flow Management
A company’s financial statements, especially the cash flow statement, reveal much of what investors and financial experts need to know. The cash flow statement shows a detailed view of how cash moves in and out of the business during a specific accounting period. While it doesn’t give a complete picture, the cash flow statement offers a quick look at a company’s financial health, revealing whether the company is growing, losing money, or holding steady. By analyzing this report, financial experts can spot potential issues and identify areas for improvement.
Top 5 Strategies for Effective Cash Flow Management
Disclaimer: These strategies are dependent on a variety of factors including your relationships and/or leverage with customers and suppliers, availability of internal resources, appetite for technology adoption, and regulatory requirements.
1. Align Customer and Vendor Payment Terms
Collecting payments quickly improves cash flow by turning potential revenue into actual cash. A good strategy is to align the payment terms you offer customers with those your vendors require from you. In simple terms, avoid giving customers more time to pay than the time your suppliers give you.
For instance, if your suppliers require payment within 30 days, but you allow customers 90 days to pay, this gap can strain your cash flow. To improve it, try to negotiate both your customer and supplier payment terms to 60 days. If successful, this should smooth out the cash flow after putting this in place for a few months.
2. Encourage Early Payments with Discounts
Offering early payment discounts is an effective way to boost cash flow. These discounts reward customers who settle their invoices within a specified timeframe. For example, you might offer a 2% discount if the invoice is paid within 10 days. Shameless plug for Quickly here, we offer a fully dynamic program allowing you to offer as little as 0.09% per day, so if you are saving 10 days, you only offer a 0.9% discount to get paid early.
Alternatively, you can try to set up interest charges for late payments. If your payment terms are 30 days, charging interest on payments made after 90 days encourages timely payments while generating extra cash when payments are late. Disclaimer: Late payment charges are rarely paid but the threat of late charges may be enough to incentivize timely payments.
Both incentives motivate customers to pay sooner, helping your cash flow by getting funds in faster and providing a buffer when payments are delayed. We are partial to Early Payment Discounts since “you catch more flies with honey”.
3. Optimize Cash Flow with Just-in-Time Electronic Payments
Many businesses now prefer electronic payments for B2B transactions, with only 5% still using checks as of 2024, according to the AvidXChange. Additionally, 76% of businesses say that paying major suppliers electronically has positively impacted their operations.
Switching to electronic payment methods like EFT (Canada) and ACH (USA) and wire transfers allow you to keep cash on hand longer by making payments at the last possible moment without risking late fees or long clearing times. This approach can help you:
- Improve cash flow management
- Reduce the workload in accounts payable
- Refine cash flow forecasts
- Simplify account reconciliation
Electronic payments offer a streamlined, efficient way to control cash flow while keeping your business on track.
4. Speed Up Collections
To minimize late payments, send invoices as early as possible, ensuring they’re clear, detailed, and directed to the correct contact. Understand your customer's invoice intake process, how they review, approve, and what details matter most. This will give you the highest odds for a fast approval and ensure your invoice is added to their payment cycle in a timely manner. Generate an invoice immediately upon delivering goods or completing services to speed up the process.
For larger orders, consider using progress based invoicing, where you request payments at various stages. For instance, you might require a deposit when the order is placed, with additional payments due at agreed-upon milestones during production or service delivery.
Stay on top of your receivables—regular follow-ups increase the chances of timely payment. Delays in communication often reduce the likelihood of recovering overdue amounts.
5. Use a Strong Cash Flow Forecast Model
This one may be obvious but to quote Peter Drucker “what gets measured, gets managed”. Using a cash flow model, updated on a weekly basis, to measure and see where your cash flow is heading. This is often overlooked or skipped in organizations but is one of the most important tools. The model should show, at a minimum, the realistic timeline for cash inflows through receivables collections and when you plan to pay your bills and obligations.
You can enhance this model by using electronic payments and transactional data. Predictive modelling software, which now leverages artificial intelligence and machine learning, analyzes this data to provide insights on when you may have shortfalls to cover or excess cash to deploy in short term investments.
By identifying patterns that traditional reporting may overlook, advanced modelling tools offer more accurate forecasts, helping businesses make well-informed financial decisions.
Conclusion
Implementing effective cash flow management techniques helps businesses optimize their funds, ensuring healthy liquidity and solvency. Through cash flow forecasting and analysis, efficient management of payables and receivables, and strategic cost control, companies can maintain robust cash levels, positioning them to seize growth opportunities.
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