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Techniques for better cash flow management

Smart cash flow management starts with financial projections and forecasting your cash flow

5-minute read

Your level of working capital is intimately related to the flow of cash in and out of your business. Simply stated, you need enough working capital to pay your operating costs until you’re paid by your customers.

If you've used a lot of that working capital to pay for fixed assets, you may come up against a cash crunch that prevents you from paying suppliers, buying materials and even paying salaries.

That’s why it's critical to maintain a level of working capital that allows you to make it through those crunch times and continue to operate the business.

Start budgeting

Making a cash flow budget should be your first priority to get a handle on your cash flow. Your bookkeeper, accountant, accounting software and even spreadsheets can help you anticipate inflows and outflows of money over a period of time.

Anticipate your cash outflows

Estimate your annual expenses and consider the incremental costs you will incur to implement your business strategy, in addition to the costs incurred to run your business on a day-to-day basis. These include:

  • payroll
  • rent
  • utilities
  • interest
  • loan repayments

Also, be sure to consider anticipated big-ticket items, such as buying a new truck, redesigning your website or updating your computers.

Anticipate your cash inflows

Estimate your annual sales and think about the effect your decisions will have on your cash flow forecast. Make sure you take into consideration your credit policy and when your customers pay to ensure your business has enough cash throughout its business year. Budgeting allows you to see when a cash crunch is likely to occur and prepare contingencies such as getting a business loan to avoid any negative consequences for your company.

Using short-term financing

Short-term financing such as a line of credit can be used to make emergency purchases or to bridge the gap between payables and receivables.

A line of credit can be negotiated with your financial institution. This should be done before any need actually arises. It's usually easier to negotiate a line of credit when you don't really need one. A good time to go to your financial institution is immediately after the end of a good year or quarter.

You may also need to increase your working capital in growth situations where you have to substantially increase inventory that will be sold on credit. Banks, shareholders or other investors can sometimes provide this cash injection and provide long-term financing for working capital.

Using long-term financing

Large asset purchases such as equipment and real estate should usually be financed with long-term loans rather than with your working capital. This allows you to spread the payments over the average life of the assets. Yes, you'll be paying interest, but you'll have preserved your working capital for business operations.

Dealing with business risks

There are many risks involved in running a business, and serious challenges should be expected at some point in the future. You need to consider various scenarios such as:

  • What if that big order suddenly comes in?
  • What if a big order is cancelled?
  • What if that important client goes under while still owing me money?

This kind of risk analysis can become part of your cash-flow budgeting process.

For instance, if you're using a spreadsheet to enter cash inflows, simply reflect a hypothetical situation by adding or deleting inflows. The repercussions in the following weeks and months should immediately be visible, so you can consider what you would do if the event occurred.

You can reduce the risk of cash crunch by planning ahead and having a more diversified client base. If you're not dependent on one large order or client, your survival doesn't hinge on the health of someone else's business. Finding new clients will increase revenue, improve your cash flow situation and make you less susceptible to marketplace adversity.

Create a separate business account

Another risk associated with running a business—especially among start-ups—is mixing business and personal bank accounts and credit cards.

This situation has a simple remedy, which consists of opening a separate bank account and credit card for your business. Your business account should be where you deposit customer cheques, draw your salary and pay your employees and suppliers.

Similarly, you can get a separate credit card for the business, make business-related purchases on that card and pay using your company account. Most credit cards provide management reports that detail the types of purchases made over the month and over the past year. This type of information can then be used in your cash flow budget for the next year.

Collect Quickly

To guard against late payments, bill as early as possible and make those invoices as clear and as detailed as possible. Also generate an invoice as soon as the goods or services are delivered and make sure those invoices are addressed to the right person.

For big orders, you may want to consider progressive invoicing while you manufacture the goods or deliver the service. For example, you can ask for a deposit with the order and then a percentage of the payment at various agreed upon milestones.

Keep track of your receivables. Experience shows that the longer you remain out of contact with a customer, the less likely you are to recover the amount owed.

Monitor your costs and your inventory

Shop around and getting quotes from other suppliers is a good way to ensure you are getting a good deal. If they won’t give a better price, they may be able to offer better payment terms—making it easier on your cash flow situation.

Analyze inventory turnover to determine which items are selling and which ones are duds that soak up your working capital. Try to keep inventory levels lean so that your working capital isn't tied-up unproductively and unprofitably.

Finally, if you feel you need help managing inventory or making cash flow projections, BDC Advisory services can help you implement working capital strategies that are just right for your business.

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