Cash Flow Management Essentials

A Guide to Better Cash Flow Management 

Cash flow management is essential for the survival of any business, no matter how large or small. Even corporates making the most profits are vulnerable to late payments and overtrading. It concerns the literal payments of money, rather than what is owed to you from debtors or creditors. While cash flow can be affected by the respective industry a company operates in, it is largely controlled by successful management. There are many factors to consider when managing cash flow: these may include customer credit worthiness, timely payments, investment and funding options, long term projections, current debt capacities, and cash conversion cycles. We recently wrote an article describing late payment culture across businesses in the UK. Late payments often result in companies not having access to cash when they need it. This article will offer a simple purview of some cash flow management essentials and how to best control it. 

Cash Flow Cycle 

Typically, cash is generated through direct sales. Some are at an inherent advantage; retailers, for instance, might purchase items on credit but also get paid in cash, offering them a lot of flexibility. The trick is to make sure that your outflows (all expenses paid out by the business) does not exceed inflows (all income flowing into the business) plus any reserves. Without a flow of working capital, businesses often fail as they struggle to meet their overheads and pay suppliers on time. Therefore, it is essential for business owners to be familiar with the timing of their outflows and inflows and to make sure there are no critical financial deficits between transactions. 

Put simply, the ‘Cash Conversion Cycle’ is the time taken between paying out for stock or inventory and collecting payments further down the line for your goods or services and largely defines a company’s cash flow cycle. A longer cash conversion cycle means a longer wait before any payment is made for a good or services you provided, resulting in greater insecurity when payments are due. A company’s payments and outflows largely consist of salaries (including tax and national insurance), overheads, stocks, raw materials, capital, and more. A long cash conversion cycle could therefore put a business at risk of not being able to pay employees their dues, nor cover other important costs to keep operations running. The cash flow cycle relates to the timing and relationships of inflows and outflows, and is incredibly important to be managed successfully. 

Cash Flow Forecasting and Financial Planning 

One of the best ways to appreciate your company’s cash flow cycle is by using accounting software to make financial projections. Doing so can make a graphical representation of the amount of cash flowing in and out of your company and the timing for when it will happen. It makes contingency planning infinitely easier, meaning that you can have backup plans in case revenue drops 20% in a certain month. This could happen if a major client suddenly stops trading, for instance. This subsequently makes cash flow budgeting much easier—only when you know how much money will be leaving your enterprise can you acknowledge how much money is free for spending. 

It is important to be conservative in assessments of your company’s cash flow; don’t expect payments to always be made on time. Furthermore, never offer more credit or product that you cannot in good faith provide. It is not recommended to account for cash sales until you have actually received the money, however you can budget for these payments to be made in the near future. It is also important that, when making projections spanning weeks or months, long-term expectations will not account for short-term fluctuations—if a client stops trading, or a product is rescinded, or stock has spoiled, it is important to update long term projections as soon as possible. It is also important to anticipate credit notes when selling perishable goods, or goods or services that have a higher potential to be disputed. As well as having a detailed cash flow forecast, it is imperative to maintain up to date management accounts for the purpose of informed decision making. Not only will accurate and up to date management accounts allow you make better decisions, they can also provide trade credit insurance companies with the information needed when your suppliers are applying for cover on your company, ultimately facilitating greater levels of trade. 

Using the Forecasts 

Forecasts must be compared with your company’s performance on a regular basis in order to monitor how accurate your forecasts are and to anticipate any problems down the line. Aim for a rate of at least once a month, and ideally once a week. If anything is underperforming, take immediate actions as you would with non-paying customers. This can prevent problems that could otherwise occur even months down the line. Say, for instance, you know you will be short of cash three months down the line—take action now to mitigate its impact. That could involve the slow reduction of stocks or growth, or perhaps to extend a credit period. It is for these reasons and more that insurance companies might want to have a cash flow budget that extends for a longer period (although for standard business operations, a 6 month projection should suffice). 

Another very important feature of financial forecasting is the ability to make contingency plans. Having a financial reserve to account for unexpected surprises is incredibly helpful and will always help keep liquidity up. An alternative to keeping a cash reserve for the purpose of non-payment of your customers debts due to insolvency is trade credit insurance. This product can allow you to better utilise your cash rather than keeping it as a reserve fund, and you will still have the peace of mind that you are covered if your customer fails. If you are using accounting software, run various scenarios that can allow you to plan for accordingly, for example if your sales dropped 10% in 2 months. Also, use the projections to find out how best to limit growth in case a financial drought comes your way. There can also be systems available that offer pre-emptive warnings in situations such as an important client ceasing to trade, or sales falling below a certain threshold value. 

Credit Control 

Credit control fundamentally concerns how a business manages what is owed to it by customers and trade debtors. A lot of these problems can be pre-emptively avoided with good due diligence. In particular, new clients that do not have an established reputation will necessarily carry a degree of risk when trading with them. It is therefore advisable to make use of the public services available to check the credibility of your customers and use a credit status agency to help determine their creditworthiness. Subscription services are available on sites like Experian or you can access information in the public domain using Companies House. Check a new customer’s liquidity levels, supply chains (and their potential weaknesses), and consider imposing a credit limit until you have confidence in your relations with them. There is one issue with basing a company’s creditworthiness on historic financial information; it is often fairly old. As previously mentioned, one way to mitigate the trading risks associated with open credit is to use trade credit insurance. Not only will the insurance pay out in the event of your customer’s insolvency, the credit insurance companies have a wealth of up to date information that is not available in the public domain. This information can be used as an extension of your credit control in determining whether or not to trade with a company and to what level.  

If a payment is late, it is imperative to contact the client as soon as possible to chase the overdue debt and keep on top of the outstanding debt. A good credit controller will benefit your company greatly by helping to ensure those overdue payment come in. However, these aspects of credit control occupy time, money, and resources. Outsourcing certain parts of your credit control is a preferable option for a lot of companies. Factoring, for instance, is a burgeoning form of finance becoming more and more popular, and involves a funder providing you cash upfront for invoices issued on credit terms. Factoring is a product that can form an essential part of your company’s operation by vastly improving your cash flow position allowing you to more easily meet your costs and even have readily available cash to aid growth. Trade credit insurance and factoring used in simultaneously can prove an invaluable combination that provides your company with elevated liquidity, peace of mind and superior insights when deciding with which companies you should trade.  

Conclusions 

In sum, cash flow management is so essential to business operations that trying to achieve growth without forecasts and due diligence would put businesses at not only a commercial disadvantage, but at risk of failure. Research the correct accounting software for your business, plan and forecast your cash flow and other financial aspects of your business, create contingency plans for the most unexpected circumstances, perform your due diligence on existing customers and new alike, minimise late payments, and consider finance and insurance to help growth and protect yourself in the event of the unexpected. 

Post Date | July 22, 2021
Post Author | Guy Letheren
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