Cash flow is crucial for the sustainability of your business for several reasons.
Firstly, cash acts as the lifeblood of your business. Efficient cash flow management ensures effective capital utilisation. A lack of sufficient cash can lead to unnecessary borrowing, while too much cash might suggest missed growth opportunities.
Secondly, cash flow provides a clearer understanding of your business’s financial health. Monitoring both the amounts and timing of cash inflows and outflows offers a more accurate picture of your business’s financial performance than an income statement. This is because income statements can be influenced by accounting techniques that may embellish earnings, whereas cash flow provides a straightforward representation of financial status.
Thirdly, proper cash flow management enables maintaining an optimal level of cash, allowing for the investment of surplus funds into business growth.
This is achieved by aligning your cash inflows with outflows, ensuring sufficient liquidity plus a safety margin for unforeseen expenses.
Here’s How to Manage Cashflow Properly
Optimal cash flow management typically involves scrutinising your accounts payable (A/P), accounts receivable (A/R), and budgeting processes. Managing inventory to meet demand without excess can also enhance cash flow.
Before you explore specific strategies for improving cash flow, consider these calculations to assess your current position:
Free Cash Flow (FCF)
Free cash flow indicates the cash available for use within the business, useful for asset purchases or workforce expansion.
Calculate it as follows:
FCF = Net Income + Depreciation/Amortisation – Changes in Working Capital in Period – Capital Extended in Period
Ensure you understand your outstanding liabilities and their payment timelines.
Operating Cash Flow (OCF)
Operating cash flow, which includes non-regular transactions like asset sales or purchases, is crucial for financing and understanding traditional cash flow.
Calculate it as follows:
OCF = Operating Income + Depreciation/Amortisation – Taxes + Changes in Working Capital in Period
Days Payable Outstanding (DPO)
DPO measures the time to clear an invoice. While extending DPO can improve cash flow, it should be done carefully to avoid straining supplier relationships.
Calculate it as follows:
DPO = Accounts Payable * # of Days / Cost of Goods Sold (COGS)
Alternative Strategies for Managing Cash Flow:
Strategy 1: Establish a Precise Budget
Base your budget on actual, not estimated, expenditures. Review your accruals and actual cash movements to understand your financial cycles. Implement a 13-week cash flow forecast to fine-tune your financial strategy.
Strategy 2: Engage in Negotiations
Engaging in negotiations with clients and suppliers can shorten cash conversion cycles or extend your cash buffer, essential for seizing strategic opportunities.
Strategy 3: Optimise Payment Processes
Enhance your accounts payable and receivable processes. Consider paying on the due date rather than in advance to conserve cash, and follow up diligently on overdue payments.
Strategy 4: Seek Flexible Funding Solutions
Explore options like accounts receivable factoring, asset-backed loans, or establishing lines of credit to maintain liquidity. A good business growth consultant will help you here.
Strategy 5: Stimulate Cash Inflows
You might consider offering discounts to rapidly boost cash inflows or providing incentives for early payment to shorten the cash collection cycle.
Summary
Efficient cash flow management is key to effective capital allocation. By understanding and implementing robust financial controls and strategic planning, you can optimise your business’s financial health.
