It doesn’t take running a business for very long before business owners realize that cash is their lifeblood. No business is safe from cash flow problems. Younger businesses can get into trouble by underestimating sales cycles, or receivable timeframes, or overestimating inventory. All businesses are susceptible to unexpected economic downturns or a cash crunch from a sudden growth spurt. Overcoming any of these predicaments can be a challenge for businesses that fail to make cash flow management their top priority.
Here are five best practices business owners can follow to ensure maximum success in their cash flow management.
Know Your Business Variables
Businesses with growth ambitions must be able to manage the many variables that impact the flow of cash in and out of the business. The true test of effective cash flow management is how the business is able to react in the face of any number of variables expected and unexpected that can impact cash flow at any time. It’s easy to prepare for some of the predictable patterns, such as seasonal shifts, inventory cycles, and monthly sales fluctuations, all of which can be built into a 12-month cash flow projection.
However, there are many variables that can come from nowhere, such as new or increased competition, an unexpected business opportunity, the loss of a key employee, changes in vendor relationships, or the loss of a significant customer. Those are the reasons why it is essential to build a three to six-month cash reserve or have a reliable lending source in place. In addition, business owners should always be working on their relationships with vendors and customers, and have a constant finger on the pulse of the market.
Anticipate the Future
A growing business will reach critical junctures in the various stages of growth, which can become obstacles without proper planning. Without a firm grasp of projected spending needs and cash flow, a business can run into a cash crunch as it tries to ramp up to the next level. Many businesses rely on financing or investment to get there. However, lenders want to see that the business has been able to hit cash flow and profit milestones over a specified period. In anticipation of the need for capital, a business should manage cash flow based on a 12- to 24-month cash flow projection. The projection, along with a business plan, should be shared with a lender long before the need for capital arises.
Monitor, Measure and Adjust Frequently
Cash flow data should be monitored monthly to identify any problematic trends on both the revenue and expense sides. Key indicators such as slowing receivables, erratic expenses, uneven payables, or increasing costs will show up on the bottom line as either an anomaly or a trend. Monthly data should be compared against cash flow projection benchmarks. If a benchmark is not met, action should be taken to counter the deficit, or an adjustment should be made to the cash flow projection. Business owners should develop the habit of questioning their projections and their assumptions to ensure they do not overestimate inflows and underestimating outflows.
Optimize Receivables and Payables
The root of most cash flow problems lied with the ineffective management of receivables and payables. Businesses that allow receivables to stretch out past 30 days or don’t have control over their payables are likely to run into cash flow problems. If allowed to continue over a period of time, these problems can cripple a business. Businesses that focus on ways to gain control over their receivables and payables are better positioned to weather the unexpected.
For example, receivables can be accelerated by convincing their customers to pay with electronic funds transfer (EFT) or Automatic Clearing House (ACH) payments. The same technology enables businesses to optimize the timing of payables, so cash doesn’t leave the business until it is absolutely necessary. Cash management tools available through a business bank enable businesses to streamline their cash flow management processes to ensure they maintain optimal cash flow.
Businesses can also negotiate more favorable payment terms with suppliers to better control their payables while clarifying invoice terms with customers to ensure more timely receivables.
Fortunately, business owners have access to many tools that can expand their capacity to manage cash flow. Accounting software programs can simplify even the most advanced tasks of small business bookkeeping and accounting. Cash management tools available through a business bank can streamline most of the payables and receivables functions through automated systems. All that is left for the business owner is to use the information these tools provide to make sound business decisions based on their data and focus on ways to improve the bottom line.