Cash flow is the net amount of cash (or cash equivalents) that flows in and out of a business. Unlike income, which includes credit such as accounts receivable, cash flow simply reflects the volume of available cash.
Cash flow plays a crucial role in ensuring a company can operate on a day-to-day basis and meet expenses, such as employee wages. Here, we highlight five key steps to improve your business cash flow.
Cash enters a business though sales or loans and flows out as payments, such as wages, supplies or interest on loans. A business may have strong sales, but without sufficient cash flow it can still become insolvent – meaning it must either stop trading or raise additional finance. There are, however, a number of ways to improve cash flow.
One of the quickest ways to optimise net cash flow (the difference between money in and money out in a set period) is to reduce the volume of cash exiting your business. You can do this by extending the length of time you take to pay your bills. For example, if a supplier’s repayment terms are 30 days, use this full allowance to improve your cash flow, rather than repaying them unnecessarily early.
If you have established a good relationship with your suppliers, you may even be able to secure a better trade credit agreement and negotiate longer repayment terms.
Increased cash flow means increased liquidity. If you’re struggling to meet your financial obligations or need a larger cushion of liquidity, you can take steps to increase your cash inflows. One way to do this is by selling assets.
It may be worth re-evaluating your business and focussing on core assets, whether that means selling off machinery, financial assets or areas of your business that aren’t key to your future strategy. Alternatively, you can try and secure an overdraft to enhance your financial security.
Improving your Days Sales Outstanding (DSO) is key to better cash flow management. DSO measures the average length of time between invoices being issued and receipt of payment.
Not only does low DSO support cash flow and liquidity, it’s also used as a measure of operational efficiency and can help you secure better partnerships and financial assistance. A good DSO figure is more attractive to banks, lenders and investors.
Make sure you extend payment terms tailored to your customers and follow best practice for setting credit limits. It’s also important to implement an effective collections process to ensure you follow up invoices as soon as they’re due and take a robust approach to late payers. Adopting an electronic invoice and billing system can help speed up payments, and you can further motivate customers by offering incentives for early payment and charges for late payment.
The best way to avoid late payments is to have an effective due diligence process to screen customers and prospects. Small businesses, in particular, are vulnerable to late payers as they tend to work with a smaller pool of clients.
There are a number of steps you can take to determine the creditworthiness of your prospects, from using a credit reference agency to consulting the Prompt Payment Code or conducting supply chain research. No matter how attractive a customer or prospect may seem, if their payment culture could threaten the stability of your company, it’s not worth doing business.
A number of cash flow problems could be prevented by effective forecasting. Try creating a 12 month forecast and monitor it weekly. Identifying cyclical or seasonal changes in income and outgoings can help you prepare better in coming years and develop a more accurate financial budget.
And as a final bonus tip – always have access to an emergency line of credit. You never know when you may need it.
Interested in more information? Read more about it in our ebook Understanding Credit Risk for Dummies