What is Cash Flow Management?

Cash flow management is the process of analyzing and optimizing the cash resources of your company.

Cash is either flowing into or out of your company. Hence the phrase, “cash flow.”

Positive cash flow occurs when the cash flowing into your business, e.g. sales, is greater than the cash flowing out. Positive cash flow enables your business to cover all of its expenses, settle debts, return money to shareholders, while still having some leftover to reinvest.

Negative cash flow occurs when the cash flowing out of your business, e.g. expenses is greater than the cash flowing in. Negative cash flow limits your business’ ability to grow and expand because it can’t fund itself at its current level. This is a huge red flag but there are remedies that can bridge the gap between your cash flows and it starts with cash flow management.

Effective cash flow management, allows decision makers to better predict the movement of cash and plan more effectively. Cash flow management can tell you if you have enough funding for a particular project or if you will be able to meet obligations as they come due.

Profit Vs. Cash

We have all heard the saying, “Cash is King.” Cash is the lifeline of any business. It ensures that expenses and obligations are being covered while also having enough to fund operations and expansion. Understanding the delicate balance between cash inflow and outflow is what allows a business to be sustainable in the long run. 

A business can be really profitable yet still go bankrupt because they are not converting their sales to cash fast enough. In fact, lack of capital is one of the leading factors for business failure.

But how can a company be profitable and go bankrupt?

For example, a company that has $1,000,000 in sales can have only $50,000 in cash. If they are generating $1,000,000 in sales, they probably have hundreds of thousands in expenses. This scenario presents a real problem. The concept is simple:  a company with the ability to generate XYZ amount in sales will probably have close to XYZ in expenses. In our example, this particular company, more than likely, does not have enough cash to operate which can lead to bankruptcy. This is why cash flow management is important.

Cash Flow Management Strategies

The primary goal of cash flow management is to speed up cash inflows and slow down cash outflows. This is frequently done by making adjustments to the sales cycle and delaying the payment of expenses.

Managing Cash Inflows

How much time you give your customers to pay an invoice heavily impacts your cash flow.

In our example, the company with $1,000,000 in sales has an accounts receivable turnover that is too low. Accounts receivable turnover (more simply put as AR turnover) is calculated by dividing total credit sales by average accounts receivable.

AR Turnover = Total Credit Sales / Average Accounts Receivable

This calculation tells you the average amount of accounts receivable collected during the year. More valuable is how long it takes to convert an account receivable to cash. That is found by simply taking 365 and dividing it by AR turnover.

AR Turnover in Days = 365 / AR Turnover

Let’s take an example. Company A has $250,000 in credit sales for the year. Their accounts receivable balance at the beginning of the period was $42,000 and $37,000 at the end of the period. First, we would need to derive the average accounts receivable balance.

Average Accounts Receivable = ($42,000 + $37,000) / 2

Average Accounts Receivable = $39,500

We can now arrive at AR turnover by dividing total credit sales by average accounts receivable.

AR Turnover  = $250,000 / $39,500

AR Turnover = 6.33

AR Turnover in Days = 365 / 6.33 = 58 days

This means that Company A’s accounts receivable “turned over” 6.33 times in the year. And the average accounts receivable was collected in 58 days.

This may be a high or low number depending on your industry. That’s why it is so important to conduct this analysis with your CFO and have a comprehensive view of the market to see what competitors are doing.

Nonetheless, if you find that your AR turnover is too high, you may want to have looser credit policies and if it is too low, you may want to have stricter credit policies.

The point of this analysis is to see how long it’s taking you to convert your sales to cash and speed up that process, if possible.

Discounts

Another way to improve cash flow is by offering discounts on your products or services if customers pay early. This strategy will have a direct effect on your sales number but can motivate your customers to pay faster than they normally would.

Managing Cash Outflows

Cash flow management not only pertains to cash inflows but also cash outflows.

If you want to improve your cash flow, take a closer look at your expenses and payables. If you find that your expenses are increasing more than your income, it’s time to make some changes.

Choose the Right Vendors

It is not always a good idea to choose the cheapest vendor. Consider the ones who have more payment options. This will give you greater flexibility over how and when you can pay them.

Delay Payments

If your vendors or creditors give you 30 days to pay a bill, don’t pay it on day 7. Set up automatic payments to pay creditors on the last day they are due. This will allow you to remain current on all of your obligations while also holding on to your cash for as long as possible.

Reduce Expenses

Maybe you’re experiencing a cash flow deficit due to overspending. Review your expenses and see where you can cut costs. Fixed expenses like office rent or salaries leave you with little to no room for adjustments but variables costs like supplies or subscriptions can possibly be reduced.

Maintaining Cash Flow Management

It is important to regularly monitor your business’ cash flow. You can do this on a monthly, weekly or even daily basis. Many accounting systems can help you generate reports, like the cash flow statement so analyzing cash flows easier.

Develop a budget and stick to it. If you can only afford to spend $1,000 on office rent, spend only $1,000 on office rent. Less, if possible, to give yourself wiggle room in other areas.

Spot cash flow trends. Over time, you should be able to see trends in cash at different points in the year. Understanding your trends will help you draw conclusions on what’s causing them and develop a plan for dealing with them.

What strategies can you implement to better manage your cash flow?

Seek the professional help of a CPA. You may find yourself too busy to deal with the ins and outs of your company’s cash flow. Cash flow is too important to be ignored completely. Consider the services LYFE Accounting offers. Contact us today!