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Cash Flow Management for Businesses

Mark Henricks
Businessman with a laptop

Cash flow describes how money flows into and out of a business. It covers a specific time period, such as a month or quarter. Managing cash flow is crucial for both individuals and businesses. Even highly profitable businesses can fail if they don’t manage cash properly. Here are the basic principles and techniques for effective cash flow management.

Cash Flow Basics: Positive and Negative Cash Flow

Positive cash flow means cash is being collected faster than it is being spent. It’s a sign of good health and means a business will likely be able to cover its bills. If the cash flow picture shows a negative figure, cash is going out faster than it is coming in.

Negative cash flow may be acceptable and expected from time to time, especially if there are major unusual expenses. However, long-term negative cash flow may mean a business won’t be able to pay employees, landlords, suppliers, lenders, utilities and others. Lack of cash can force a business to close its doors or seek bankruptcy protection.

Elements of Cash Flow

Here are the major elements that go into understanding and managing cash flow:

  • Cash balance – This is the total amount available for spending in all your business checking, savings and investment accounts and petty cash.
  • Accounts receivable – This is the accounting of all the money your business is owed, as well as when payment can be expected to arrive.
  • Accounts payable – These are all the bills that are due, including their totals and the dates they must be paid.

Cash Flow Statement

In order to manage cash flow optimally, businesses need a record of money that flowed into and out of the business during a set period. That record is called a cash flow statement, and it shows how much cash various activities produce. These statements, which can be calculated either directly or indirectly, typically include three parts:

Operating activities – Tracks cash flow that’s generated once the company delivers its services and goods and includes both expenses and revenue

Financing activities –  Tracks cash flow from the sale or purchase of physical property, like equipment and real estate, and intangible assets, like patents, trademarks, and copyrights

Investing activities – Tracks cash flow from debt and equity financing

One of the most important parts of a cash flow statement is working capital, the amount of money needed to run the business.  Computing working capital gives you a quick analysis of the liquidity of the business over the future accounting period. If working capital looks adequate, a cash flow budget may not be needed, but if working capital looks inadequate, a budget may avoid future liquidity problems.

Cash Flow Budgeting

Cash flow chart

With a cash flow statement in hand, businesses can begin cash flow budgeting. The time frame for these budgets can vary from one week to one year.

A budget can be made with a simple spreadsheet. At the top is the period’s starting cash balance, totaling all available accounts and money on hand. Next, list all expected income. This may include payments expected from customers as well as receipts from loans. After that list all payments. Include the balances as well as the date they must be paid. Adding income to cash and subtracting payments from the total gives the ending cash figure. If the figure is badly or persistently negative, it will take action to keep the business afloat.

Managing Cash Flow

How much cash a business needs depends on expected cash needs and ability to tap other cash sources, such as loans, if necessary. Having a lender to turn to for assistance can make all the difference when cash flow shrivels.

Managing accounts receivable is one part of wise cash flow management. Invoice promptly. Cash on hand should be kept, as much as possible, in interest-earning accounts. Aim to collect money due the company as fast as possible without alienating customers or making it harder to buy from you. Be cautious about who you extend credit to. Consider requesting advance payments on large orders.

Managing accounts payable is also key. Pay creditors as slowly as possible without causing them to give you poor service or, worse, start demanding cash on delivery. Communicating with vendors to find out how they want to be paid and how flexible they can be on terms is an essential part of this process.

To further conserve cash, think about delaying equipment upgrades and repairing instead of replacing. You may even consider bartering or paying in kind for needed goods or services rather than relinquishing precious cash.

Cash Flow Missteps

Business owner checks his cash flow

Skillfully managing cash flow is an essential business skill, but it is easy to make mistakes. Problems often result when customers pay slowly, reducing the inflow of cash. Cash can also be throttled by a revenue slump.

Businesses may create their own problems by making ill-timed investments, buying too much inventory or paying creditors too quickly. Poor record-keeping can lead to business owners being surprised by bills they weren’t prepared for.

Growing too quickly can cause a cash crunch. A large order from a new customer may require a business to spend cash to hire staff and build stocks of materials. If payment for the order doesn’t arrive before workers, suppliers, landlords and utilities must be paid a business can fail even while growing and making profitable sales.

The Bottom Line

When business owners say “cash is king” they’ve said a mouthful. Managing cash flow is a critical skill for the majority of businesses. Even a business that is growing and making profitable sales may find it is forced to close down because it can’t pay workers or suppliers if cash is not skillfully managed.

Tips for Business Owners

  • Consider working with a financial advisor experienced in working with business owners. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
  • Creating a personal cash flow plan might feel intimidating, but it’s an important step towards maintaining your financial health. SmartAsset created a budget calculator to help make things easier for you. Plug in your income, location, family size and expenses to see how you’re doing.

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