Guide - The art of cash-flow management: What do I need to be aware of?
strong>What is cash-flow?
Much is made of the importance of maintaining a healthy cash-flow, but it is often the case that business owners and managers don’t properly understand the ideas behind the words. So, just what is cash-flow and what does it mean for your business? A simple definition of cash-flow would summarise it as the way in which cash comes into your business, moves around it and leaves the other side. It is essentially a measurement of how free capital is to enter, circulate and leave a business without becoming tied up.
Why is it important?
Cash-flow is important to a business because it is an indicator of whether a company is stable or secure, but also whether it has the potential for expansion. A healthy cash-flow will illustrate to investors and creditors that the business is suitable for continued trading and will prove a good investment, a factor that means a lot, particularly in times of economic hardship. On the other hand, poor cash management and an unhealthy cash-flow is one of the main reasons that small and medium sized businesses fail. Unable to pay their debts or meet other obligations because too little free cash is coming into the business, they often collapse. If you think that your business is heading in this direction, a company insolvency service such as Moorfields could offer specialist advice.
Profit & cash-flow
When it comes to understanding cash management, it is important to appreciate the relationship between a businesses profit and its cash flow. While many new businesses take profit as the sole indicator of success, cash flow is just as important. Realising that profit does not equal cash flow is one of the most important lessons for any manager or owner of a business. While profit is measured simply by subtracting expenses from revenue, cash flow takes into account a huge range of other variables. These include factors such as inventory, capital expenditures, debt servicing and accounts payable. It’s vital to remember that profits can sometimes be misleading.
Know your balance sheet
With this in mind, it follows that the art of cash flow management largely depends on a manager’s knowledge of their balance sheet and what changes are taking place on it. Having such information to hand is the first step to better cash management, as it gives you access to absolutely everything that is happening within the company. An up-to-date balance sheet that is kept in good order will not only work as an effective early warning system for cash-flow shortages, but also allow those in charge to isolate problems far more easily, thus making the process of rectifying them much simpler.
Tighten credit restrictions
While many small and medium sized businesses feel the need to loosen credit restrictions on clients in order to lure in new customers, it is important to leave this habit behind as soon as possible. Tighter credit checks ensure that all customers are able to pay on time and in full without any issues. This not only guarantees that you have cash coming into the business but also means that you aren’t wasting valuable time, resources and money in chasing unpaid debts.
Increasing sales seems like the obvious solution to most problems for a business and, while it may often be the case, it is important that increases in sales occur in certain ways. For instance, if sales are increased at great expenditure of time and resources or purchases are made on credit, this could simply increase the amount owed to a business, rather than making its cash flow any healthier. If a business can sell more to existing customers by refining its business strategy and practices, and can do this without making the majority of sales on credit, it should benefit both the company and its cash-flow.
Poor stock management and inventory taking is often seen as a great contributor to poor cash management. If inventory is being purchased, or mismanaged, more quickly than it can be sold, a company will soon find that it has much of its cash locked up and sitting in the stockroom. This can cause large cash-flow issues in the long run and is a problem that needs to be dealt with early. Proper stocktaking and ordering, making alterations depending on relevant information, should help bring the issue under control and free up some much needed cash.
Though a failing business is likely to have cash-flow problems, it is also important to remember that growth in successful businesses can have the same effect. Though a lot of money may be coming into the business at such times, it is still important to monitor exactly how it is moving, whether it is tied up somewhere in the business or whether it is exiting freely.