Maintaining a flourishing cash flow is a critical aspect to maintaining business sustainability. Cash flow problems are a very common cause of business failure.
It is important to make a distinction between cash flow and profitability. Both cash flow and profitability are needed to secure the long term success of your business. However, they will each impact your business in different ways.
A business can be profitable, but it may not have enough cash reserves to cover financial obligations. For this reason, even a profitable business, can be forced to close down if it does not have cash available when it is needed.
Alternatively, a business that is not profitable can still have a surplus of cash resources. Naturally, this surplus will be eroded if it cannot be replenished with company profits. If the amount cash flowing out of your business exceeds the amount of cash coming into your business, you cannot continue to operate in the long term.
Finding the optimum level of profitability depends on maximising your gross profit on goods to services sold. Innovative sales and marketing strategies can help you increase sales volume, revenue and total profits. On the other end of the spectrum, businesses can increase their profit margins by controlling business expenditure and running leaner and more streamlined operations.
It is essential to take a pro-active approach in managing business cash flow. Ensure that you do not misjudge the level of cash reserves needed to meet business requirements. Businesses should be vigilant in estimating the impact of a cash flow shortfall before it actually eventuates.
Effective cash flow management can be used to uncover periods when your business will be low on cash reserves. This helps you put a contingency plan in place to overcome challenges. An effective cash flow forecast will assist you in meeting financial commitments during periods when your business is vulnerable.
An important aspect to cash flow management is developing an understanding of the operating cycle of your product.
In the typical operating cycle, cash is used to buy raw materials or components. These raw materials and components are then manufactured into merchantable products. These products are then sold to customers on credit and are thus transformed into debts. When debts are recovered, the product is then converted back into cash.
A break down in this cycle will have an impact on your cash flow. For example, if your customers do not pay on time, business debts will increase and cash reserves will diminish. Without cash reserves, you cannot purchase raw materials for manufacturing products. Lower product inventory levels impede your ability to make more sales. You cannot sell a product you do not have. Less sales result in less profits. A decrease in profitability will have negative consequences for your future cash flow.
Cash flow management becomes increasingly essential during periods of economic recession. Most businesses actually experience challenges in maintaining their cash flow as the economy moves into a recovery period, rather than during the recession itself. As the economy begins to recover, sales begin to increase. As a result, the organisation needs more cash reserves to invest in producing enough products to keep up with the increase in demand.
Steps you can take to protect your cash flow:
Maximise your profitability: Eliminate unnecessary expenses. Seek continuous improvement and streamline your business processes. Develop effective sales and marketing strategies to increase your customer base, sales revenue and total profits.
Make sure your customers pay on time: Be pro-active in your accounts receivable practices. Ensure that the payment period described in your terms and conditions of sale is suitable for your business. Be proactive in debt collection and overcoming payment disputes. If necessary, businesses can offer incentives to motivate customers to pay on time.
Take advantage of credit facilities for large purchases: Purchasing on credit can help free up your cash reserves. Large capital expenses can be paid off in smaller increments over time. This minimises the impact of the expenditure on your cash flow.
Maintain the correct inventory levels: Holding too much stock locks up your cash reserves. Ensure that you have enough stock to meet demand without incurring excessive inventory surpluses.
Develop a budget: This can be used to forecast and monitor your business performance over a specific period of time. A budget provides the organisation with a plan for the allocation of company resources. In addition to this, a budget can also prove to be helpful when negotiating with the bank or other lending institutions.
Alan Tollemache is a Sydney based Bookkeeper and Accountant providing accounting, bookkeeping, business and finance services to help organisations meet their objectives. He prides himself on delivering excellent client service.