The Fundamentals of Cash Flow Management
You Don’t Need Credit if You Have the Cash
Target Audience: Small Business Owners, Financial Managers, Improving Cash Flow Interest, Analyzers, Budgeters, Operations Improvements
If you’re a business owner, you’ve likely either been directly affected by the credit crunch or at least thought about how it could affect your company. Unfortunately, tight credit has left many businesses scrambling for ways to finance their operations in recent months.
Perhaps the simplest solution to this problem is one that often gets lost in the shuffle: cash. That’s right, cash. If your cash flow is strong, your need for financing may be much less — or at least less pressing. Let’s review some fundamental ways to keep those dollars flowing.
Look at your budget to improve Cash Flow
It’s hard to know how to improve your cash flow unless you can sit down and see precisely where your money is going. That’s why the first essential cash flow analysis tool is your annual budget.
Examine it line by line. Although maintaining a detailed budget for all company expenditures can be tedious, it’s fundamental to good cash flow management. Your budget can facilitate expense tracking and help guide spending decisions to align with your business goals.
Items in your budget should tie into and support overall company business goals. If you can’t effectively demonstrate how an item enables a particular business goal, you should question its merit. This will help you avoid unnecessary spending and make more funds available for allocation to worthier business needs.
Also bear in mind that, for analysis purposes, a budget is useful only if you update it regularly to accurately reflect your actual spending. For instance, you may have overbudgeted or underbudgeted on some items and, thus, spent more or less than you anticipated.
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Create a cash flow statement
With your budget as the foundation, work with your CPA to create a cash flow statement. The purpose of this document is to report your business’s net increase or decrease in cash.
The statement factors in the cash inflows and outflows of daily business operations, asset purchases, sale proceeds and financing activities. Because it excludes noncash accounting items, you can use it to pinpoint cash flow problems.
If you want to get the most from your cash flow statement, you’re likely best off generating one monthly. But quarterly and annual statements can be useful for identifying cash flow trends. Accounting software packages can help automate and simplify the process of preparing these and other essential financial reports.
Manage expenses for your company’s cash flow
After securing an overview of your company’s cash flow, you can start examining specific areas. One in particular is expenses. Here, too, you should look to your records.
Maintaining accurate expense records gives a more complete view of your financial situation, putting you in a better position to effectively manage your company and ensure ongoing profitability. Accounting software can help you automate the meticulous process of expense account organization and records tracking.
As you review your expense data, seek out ways to reduce your company’s day-to-day operating expenses. For example, you may find it more economical to outsource noncore areas of the business such as human resources, payroll and benefits management or information technology support.
Or you might implement just-in-time inventory management, with suppliers maintaining inventory for your business as long as possible, saving you storage and interest costs.
Review collections and payables to prevent accounting errors
Timing is critical when it comes to both the money coming in and going out. Conduct credit and reference checks on new customers to validate their payment histories and minimize the risk of collection problems. Consider requiring customers to provide deposits on product orders or services to be rendered and offering discounts for paying invoices early.
Are mistakes hurting you? Prevent invoicing errors and costly collection delays by maintaining current and accurate customer account data. Promptly send invoices to customers — fax or e-mail delivery could quicken the process. Also, follow up quickly on past-due accounts. Don’t wait until accounts are 60 or 90 days late.
On the flipside, take a look at your payables. Generally, you shouldn’t pay invoices earlier than required unless you’re offered a discount. Use your buying power for large-volume and frequent purchases as leverage to negotiate discounts, free financing or extended payment terms.
Operate within your means in the economic downturns
When the economy presents challenges, a business is often best off focusing on its core strengths, cutting expenses and operating within its means. Doing so will help keep cash flow strong and lessen your dependency on outside parties, such as lenders, over which you have no control.
What went wrong? An example of cash flow problems
Like credit card debt, cash flow problems can easily sneak up on you. One minute you’re in tip-top shape and the next you’re desperately looking for answers. What went wrong?
Consider the following fictitious example: Wishful Widgets was offered the opportunity to buy a larger quantity of inventory than usual from a supplier to take advantage of a volume discount. Initially, it sounded like a good idea.
Unfortunately, the inventory turned out to be particularly slow-moving. So Wishful wound up paying more in storage costs, interest expense and possible obsolescence than the discount was actually worth. In addition, it sacrificed the chance to stock more fast-moving goods.
The moral of Wishful’s story: Look at all the potential consequences of a financial decision before you leap into it. Otherwise it may adversely affect your cash flow in a way you didn’t anticipate.
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