How to Improve Cash Flow?
Managing how cash flows in and out of a business is one of the most important financial issues businesses face, no matter how big or small.
Even if your business is profitable and is bringing in enough revenue overall to cover your costs, that doesn’t mean that you will always have enough cash to operate. If you don’t have enough cash in the business at any given time to meet your current financial obligations such as salaries, rent or tax, it can spell the beginning of the end for your business.
Why it’s important to get cash flow under control
The more serious repercussions of poor cash flow management include being forced into insolvency, increased debt or being forced to draw on personal savings.
However, there are also several opportunity costs of poor cash flow management including:
- Misuse of capital. When you’re forced to draw on cash reserves, it reduces the available capital to be deployed into business growth or other important priorities.
- Impacts to profitability. Cash flow bottlenecks can lead to unmet profit potential.
- Poor decision making. When a business is desperate to stay afloat, it can lead to the business needing to resort to non-commercial lending or equity terms which are detrimental to the business in the long-term.
- Stunted growth. As your business scales and you have larger contracts with larger companies, often the payment terms will increase, putting even more pressure on your cash flow. This can stop growth plans in their tracks if the right systems aren’t in place to manage it.
Ultimately, improving cash flow not only reduces the stress of short-term cash bottlenecks but also mitigates risk and maximises profitability over the long-term.
So, how can you get your cash flow under control?
Forecast your cash flow
In order to gain full visibility on your cash flow, you need to create a forecast. By forecasting cash flow you can ensure your business has enough cash at all times to operate, avoid overspending and ensure you don’t run out of cash reserves.
A cash flow forecast will track when money is entering and exiting the business and when. A sound cash flow forecast will arm you with the right data to make important business decisions to keep your business operating sustainably and successfully.
Your forecast will track whether you’ll have enough cash coming in and cash reserves to cover the cash going out, your cash burn rate (i.e. how quickly you’re burning through cash reserves) and your closing cash balance. It should be detailed, updated regularly, take into account any large one off purchases and include a buffer for unexpected costs.
Your accountant is best placed to create a detailed cash flow forecast for you which covers all sources of cash in and cash out, draws on the data from your accounting system and closely reflects how your business operates including your chart of accounts.
Add a recurring revenue stream
If your business has lumpy cash flow where your cash inflows and outflows are inconsistent each month, then this will mean there will be some months where it’s more challenging to cover your costs. What you want is reliable and consistent income so you can cover costs every month, not just some months.
One way to smooth out lumpy cash flow is through introducing a recurring revenue stream. This refers to revenue which repeats regularly, for example monthly, giving you greater consistency and predictability. This includes subscriptions, retainer contracts or membership programs which give you a reliable source of the same income at regular intervals.
Streamline accounts payable and receivable
Improving your payables and receivables processes can make a big difference to your cash flow. Make sure you invoice or bill promptly and have a process for following up overdue payments. Charging interest on overdue invoices or bills can be a disincentive against not paying on time. Alternatively you can incentivise early payments by offering discounts.
You may also want to look at how you structure your invoicing and billing. Charging at the beginning of the month for the month ahead will shorten the time to payment. Charging a deposit or milestone payments for projects will ensure you’re paid more regularly rather than in one lump sum.
For accounts payable, you want to incorporate as much flexibility as possible into the process including longer payment terms when possible. You may be able to re-negotiate creditor payment terms or work with suppliers who are more flexible. Keep an eye on due dates for invoices and bills and pay as close to that date as possible. Switch from yearly to monthly payments for subscriptions to minimise lumpy cash flow.
One benefit of your cash flow forecast is that it enables you to plan ahead to accommodate large expenditures such as tax or other large expenses so you don’t face any surprise cash flow bottlenecks.
Proper planning will also enable you to account for any slower periods in your business. Looking back over your financials will reveal any trends regarding when your income rises or falls. For example, some businesses will experience a dip in the holiday period, others will be busier than ever. By accommodating this in your forecast you can plan your expenditure to occur when you have more cash when possible or build a large enough reserve to cover those costs in the quieter periods. Often cash flow is required when you can least afford it, so you need to be prepared.
Manage liabilities effectively
Managing your financial obligations such as wages, superannuation, leave entitlements, money owed to suppliers and tax effectively is crucial.
This includes having enough cash available to pay out employees’ entitlements when they exit the business such as annual leave or long service leave. It’s a good idea to ensure your employees aren’t accruing a large amount of unused leave which could equal a large payout should they leave.
This also includes your tax obligations. Proper tax planning will enable you to have an idea of your tax obligations ahead of time so you can plan accordingly and put money away. Not being able to cover your tax payments can create serious issues. If you don’t pay your tax on time it can attract interest and/or penalties.
One way to ensure you have enough cash put aside for these obligations is to use a separate bank account. This will help you maintain a cash reserve to cover these costs so you’re not caught out when these costs come up.
Certain liabilities or costs will be fixed, like wages or superannuation, but others may be flexible. In this case you may be able to reduce these costs, reducing cash flow pressures. It’s important to not just set and forget your expenses. You should be constantly reviewing expenses to assess whether they can come down, be dropped or whether you can switch providers or suppliers. For example, perhaps you can find a better deal on insurance or internet, it might be a good time to negotiate your lease or downsize to new premises, or you may be able to cut down discretionary costs like gifts or entertainment.
Hold a cash reserve
Having a cash reserve is absolutely essential to ensure you have cash available at all times to cover your costs. Understanding how much money should be held in reserve comes down to having an accurate understanding of your working capital requirements as well as an accurate cash flow forecast. Your accountant will be able to calculate this for you. Splitting your bank accounts so that some cash is held in reserve for larger expenses or seasonal downturns is a great way to ensure you’re not encroaching on that cash reserve day-to-day.
At Keeping Company, we’re not just accountants, we’re business people too. With our counsel, your business can reach its full potential.
For all media enquires please contact Tracy Miller, CMO, Keeping Company 0414 898 452.
The material and contents provided in this publication are informative in nature only. It is not intended to be advice and you should not act specifically on the basis of this information alone. If expert assistance is required, professional advice should be obtained.