Manage Your Cash Flow

Most business owners have heard the term “Cash Flow.” Many will even say, “I manage the cash flow daily.”  But the reality is that a very large number of these business owners don’t really understand the concepts of cash flow or the strategies to manage it.

Here Are Some Examples

A CEO of an engineering/design company manages income and profit on a project-by-project basis.  He says that for every project he is meeting the projected project hours, but the company is losing money. Why? Because on his project expense forecast he does not include an apportionment for all the company overhead costs like the large number of overtime hours paid to hourly employees at time-and-a-half.  These overtime payments along with other “operational” expenses were adding up to 20% of project revenue. These costs created negative cash flow for most of his projects.

Another is a CEO who does not need to watch cash flow because, “…the bank account always has plenty of money in it.”  He pays ahead on bills and pays vendors as soon as he gets the invoice.  He gives a generous 30-day payment term on his invoices.  Then one day he tried to write a check and there is no money in the account. Why, because his “gut feeling” on cash position was not in sync with the real cash flow dynamics of his business.

Cash Flow Definitions

Just to be sure we are on the same page cash flow is essentially the movement of all money into and out of your business. It’s this cycle of total cash inflows and total cash outflows that determines your business’s solvency.

Other definitions you should understand are:

• Cash Flow Dynamics: The effects on cash flow from operational process and procedures over time
• Cash Position: The amount of cash you have available at any point in time while considering the operational demands for cash that are pending
• Cash Flow Conversion Period: The amount of time it takes to receive the cash once you have satisfied your obligation to your customer (product shipped, service completed, etc.)
• Cash Flow Gap: The amount of your cash deficit at any point in time

Managing Cash

Cash flow analysis involves examining the financial components of your business that affect cash flow, such as accounts receivable, inventory, accounts payable, investments and credit used. By performing a cash flow analysis considering all these separate components (sources and uses of cash), you’ll be able to more easily identify and solve cash flow problems and find ways to improve your cash flow dynamics.

Equally important to cash flow tracking is cash flow forecasting.  The cash flow forecast shows how cash is expected to flow in and out of your business in the future. It’s an important tool for cash flow management, letting you know when your expenditures are too high or when you might want to arrange short term investments to deal with a cash flow surplus. As part of your business planning, a cash flow forecast will give you a much better idea of how much capital investment your business may need.

Closing the Cash Flow Gap

Either your cash flow analysis or forecasting can show you a cash flow gap.  A cash flow gap occurs when your cash inflows and cash outflows don’t keep pace with each other, leaving your business short of cash. This is an especially common problem for small businesses where cash outflows may often precede cash inflows.

Keep a close eye on your cash flow, so you can forecast potential cash flow problems and take steps to remedy them before they actually happen.  Take steps to shorten your cash flow conversion period, so your business can bring in money faster. Here are a few steps to consider. Work with an experienced accounting professional to discover more:

• Preparing customer invoices immediately upon delivery of your goods or services to the customer. If you wait to prepare your invoices, like at the end of the month, you may be adding as many as 30 extra days to your cash flow conversion period. If you are already sending invoices out within seven days of completing your obligation, consider reducing that time to 3 days. You will see a dramatic improvement in your cash position.
• Monitoring your customers’ use of credit and adjusting their credit limits accordingly. If the amount owed is increasing each month you may have a credit problem.  Don’t wait too long to take corrective action.
• Establish a line of credit that is immediately available when needed. This can be used to handle short term cash needs. Then, pay back the short term loan when you get the cash to pay it.
• Offer customers an incentive for paying their invoices early. For instance, if your usual policy is to have payments due in 30 days, offer a small discount such as 2 percent to customers who pay within 14 days. If you are already doing this, start writing contracts with payment terms of 15 days.
• Establishing a deposit policy for works in progress. For example, if you deliver a service, such as software development, training, or architectural services, you can adopt a policy that customers pay a certain percentage of the total invoice up front before the job begins. Likewise, don’t hesitate to build “milestone” or “progress” payments into the contract.
• Tracking your past-due accounts and actively pursuing collections. Most accounting software programs let you easily track past-due accounts, but you also need to have a clear process for pursuing collections. Such a process might involve sending out a series of letters letting your customer know that their account is past due and what steps will follow if they do not pay, such as turning the account over to a collection agency. A middle ground step may include a customer committed payment schedule to “catch-up.”
• Use “power invoices.” Invoices that say due on receipt or due in 30 days are saying “pay when you get around to it” to your customers.  Worse yet are invoices or statements that age what is owed by “current, 30 days, 60 days, 90 days.”  By showing the aging you are saying you are willing to carry what’s owed for that length of time.  Instead write invoices with a specific due date such as, “Due June 28, 2019.”

You have to have money coming in regularly to maintain an adequate cash flow for your business. Analyzing and forecasting your cash flow and taking steps to shorten your cash flow conversion period will go a long way toward eliminating those dangerous cash flow gaps.

About the Author

Bill Warner is co-founder and Executive Director of EntreDot, a non-profit organization that helps entrepreneurs start new businesses. He is also a Fund Executive of the Inception Micro Angel Fund (IMAF-RTP), an angel investor organization and Managing Director of Paladin and Associates, a business consulting firm.