5 Ways To Improve Your Business’s Cash Flow
Business is a balance of Expenditure, Profits & Revenue. Sustenance of these in the proper ratio is crucial for any entity. Forecast of great deals or closures might give a positive vibe but in the absence of an inflow of funds, survival can become difficult. For any business large or small, maintaining a smooth cash flow will require managing every aspect of the business, right from balancing payables to receivables, tracking inventory to sales, taking care of credit lines, etc.
Liquidity is vital for any business. The time delay between payment to suppliers and employees and collection from vendors and customers is a major problem and the only solution is proper cash flow management which can be a very complex undertaking.
A consistent cash flow not only helps in creating a predictable future for businesses but also contributes to future planning, budgeting, and reduced fixed capital needs. If you are serious about managing your business’s cash flow, the tips mentioned below will be useful.
Cash Flow: What It Is, How It Works, and How to Analyse It?
Cash flow is a financial metric that tracks the amount of cash and cash equivalents that are flowing in and out of business over a specific period. It is a critical measure of a company’s financial health, as it shows how much cash is available for the business to operate, pay off debt, invest in growth opportunities, and distribute to shareholders.
Cash inflows come from sources such as sales revenue, investments, and loans. Cash outflows are expenses such as rent, salaries, inventory, and debt payments. When a business’s cash inflows exceed its outflows, it has a positive cash flow, while a negative cash flow occurs when the outflows exceed the inflows.
Analyzing cash flow involves looking at the different components that make up cash inflows and outflows. The three main categories of cash flow are operating activities, investing activities, and financing activities. Operating activities are the day-to-day activities of the business, such as sales revenue and expenses. Investing activities include buying and selling assets like property or investments. Financing activities include obtaining funding from loans, issuing stocks, or paying dividends.
To analyze cash flow, businesses can use financial statements like the statement of cash flows, which summarizes the cash inflows and outflows for a specific period. It is also important to calculate the cash flow ratio, which compares cash inflows to cash outflows to evaluate a company’s liquidity. Additionally, analyzing the cash conversion cycle, which measures the time it takes to turn inventory into cash, can help identify opportunities to improve cash flow.
Cash flow is a vital financial metric that businesses must understand to manage their financial health effectively. By analyzing cash flow and implementing strategies to optimize it, businesses can maintain liquidity, support growth, and create long-term value for stakeholders.
Cash Flow Management
Mentioned below are 5 ways to manage cash flows:
- Review and Forecast – The first and the most important thing to do is to review existing vendors and customers, an analysis of who is prompt and profitable and who is not. Aligning payment timings of important or early expenses or vendors with prompt and profitable suppliers. Having a good grip on inflows and outflows and a forecast of both short term & Long term will be helpful. Conducting a good credit check on vendors or customers is also vital.
- Sell Invoices – Alternate form of financing is one of the best ways to manage your cash flows. A simple and effective solution is bill discounting. Get your invoice discounted on an agreed percentage and get your business going. Invoice discounting is a form of short-term borrowing often used to improve a company’s working capital and cash flow position. Invoice discounting allows a business to draw money against its sales invoices before the customer has actually paid.
- Overdraft Facility– Overdraft facility is a good option but comes with its own hassles. In the event of payments getting delayed beyond your control, the repayment will add to a headache. However, if you are confident about the receivables this facility is a good option. Most banks will easily extend an overdraft on the business’s account. Covering short-term needs and emergencies with a line of credit could be an effective way to manage the business. Negotiate competitive rates and use the facility when required
- Renegotiating Contracts– If you have been in business and have been dealing with a vendor or supplier for a long time now, renegotiating the terms of payment might be a good idea. If businesses know how easy it is to work with you, they might be willing to reconsider and draft a new term giving way to a more relaxed cash flow environment.
- Inventory Management– One of the major reasons for the cash crunch is overstocking inventory. Regularly gauge your inventory and sales to determine future requirements.
Cash flow problems and its associated issues are well documented. Businesses need to streamline every facet of the business to get things going seamlessly.
5 Ways to Improve Your Business’s Cash Flow with An Example
Here are five ways to improve your business’s cash flow:
1. Invoice Financing/Discounting
Invoice financing/discounting is a financing option where a business sells its accounts receivables to a third party (a lender or a factoring company) at a discount in exchange for immediate cash. This method can provide a business with quick access to cash that can be used for operational expenses. For example, if a business has $100,000 in accounts receivables that they sell to a lender at a 2% discount, they will receive $98,000 immediately instead of waiting for customers to pay them over time.
2. Negotiate Payment Terms
Negotiating payment terms with customers can be a significant way to improve cash flow. For instance, businesses can incentivize customers to make payments sooner by offering early payment discounts or charging late fees for payments made after a specific date. This can speed up the collection process, reducing the time it takes to turn sales into cash.
3. Reduce Expenses
A company can reduce expenses to improve cash flow. For instance, they can cut non-essential expenses such as business trips, reduce inventory levels, or negotiate better deals with suppliers to decrease the cost of goods sold. This can help free up cash that can be used to cover other expenses.
4. Increase Sales
Increasing sales is another way to boost cash flow. For example, businesses can implement targeted marketing campaigns, expand product offerings, or improve customer service to attract new customers and retain existing ones. This can help increase revenue, which in turn can improve cash flow.
5. Manage Inventory
Effective inventory management can help optimize cash flow. A business can reduce inventory carrying costs by managing inventory levels, improving demand forecasting, and negotiating better deals with suppliers. This can help free up cash that can be used for other expenses or invested in growth opportunities.
An example of invoice discounting as a way to improve cash flow is when a business sells its outstanding invoices to a lender or a factoring company at a discount. For instance, if a business has $100,000 in outstanding invoices and a lender offers to purchase them at a discount rate of 2%, the business can receive $98,000 in immediate cash instead of waiting for customers to pay. This method can help improve cash flow by giving the business the cash it needs to cover immediate expenses or invest in growth opportunities.
Cash Flow vs. Profit
Cash flow and profit are two different financial metrics. Profit represents the difference between revenue and expenses over a specific period, while cash flow reflects the actual amount of cash flowing in and out of a business over the same period. A business can have positive profits but negative cash flow if its expenses exceed its cash inflows. In contrast, a business can have negative profits but positive cash flow if it has significant cash inflows from financing activities, such as issuing stock or borrowing funds.
To summarize, cash flow is a crucial financial metric that measures a company’s ability to generate and manage cash. By analyzing cash flow and implementing strategies to improve it, businesses can optimize their financial performance, support growth, and create long-term value for stakeholders.