The complete guide to effective cash flow management

Introduction to cash flow

Cash flow is either positive or negative. Positive cash flow is when cash inflows exceed cash outflows. Negative cash flow is the reverse. Cash flow management is the process of tracking, analysing, and controlling cash movements in order to maintain adequate liquidity to run daily operations and fulfil short-term obligations.

Successful cash flow management ensures a healthy cash position, allowing businesses to cover operating costs, fulfil financial commitments, make smart investments, and prepare for future financial challenges. Effective cash flow management guarantees the long-term financial health, stability, and sustainability of a business.

Cash flow categories

Effective cash flow management requires an understanding of cash flow categories. These are:

• Operating cash flow, or cash flow from operations, such as the sale of goods and services.
• Financing cash flow, or cash flow from financing activities, such as bank loans, stock sales, and paying of dividends.
• Investing cash flow, or cash made from/spent on investment-related activities, such as asset sales.

Understanding cash flow statements

A typical activity in cash flow management is preparing cash flow statements, explained in detail in our article 'What Is A Cash Flow Statement And How Do You Prepare One?'. A company's cash flow statement records how much cash it made and spent from the three activities mentioned above in a given period.

Cash flow statements count as mandatory financial statements along with balance sheets and income statements. Across the world, they are prepared in accordance with stipulated norms such as the Singapore Financial Reporting Standards, International Financial Reporting Standards, and US-centric Financial Accounting Standards Board.

They can be made using either the direct method of accounting or the indirect method.

Cash flow statements contain insights on how and where companies make money and pay expenses. This information helps them preserve enough money to meet operating expenses and repay debts. It also contributes to worthwhile cash flow management strategies.

By exposing underlying problems and providing an overview of company finances, these statements assist business in planning their moves intelligently.

Cash flow analysis

Regular cash flow analysis is mission critical for improving cash flow. Examining cash inflows and cash outflows over time reveals trends and patterns that support informed financial decisions.

For example, a positive cash flow looks good on the outside but a proper analysis will tell if it is on account of robust sales or excessive debt financing. By unearthing hidden cash flow issues, a cash flow analysis ensures swift corrective action is taken.

Along with cash flow statements, a cash flow analysis uses other key indicators to assess a company's cash holdings. Free cash flow is one. Calculated as net operating cash flow minus capital expenditures, it measures the ability to generate cash beyond operational needs. However, what free cash flow really indicates is how much left-over money a company has that can be used for paying dividends or repaying bank loans.

Another indicator is operating cash flow margin. It measures the rate at which a company converts sales into cash flow, serving as an indicator of operational efficiency, earning ability, and profitability.

Techniques for managing cash flow

An effective cash flow management process not only tracks cash movement but also predicts future needs and optimises accounts receivable and accounts payable. Here are three cash flow management strategies to optimise cash flow and make the most of financial resources:

1. Cash flow forecasting

This technique involves predicting net flows and balances in the future. Businesses use cash flow forecasts to anticipate cash inflows and outflows during an impending period, pick on early signs of a potential shortfall, and take corrective action.

Apart from anticipating cash shortages, predicting future cash flow also allows companies to plan for cash surpluses that can fuel business growth.

Predicting the future isn't an exact science, but cash flow forecasting has proved an effective method of future planning. By leveraging historical data, industry trends, and economic conditions, it is possible to plan confidently for future operational, financial, and investment activities. Cash forecasts are crucial if one hopes to have enough cash without resorting to borrowings and asset sales.

How to create a cash flow forecast

Once the reporting period has been picked, follow these steps:

1. Take note of the opening cash balance.
2. List all anticipated cash inflows for the period, including cash receipts, tax refunds, incoming investments or financing, etc.
3. List all expected cash outflows, including operating costs. Don't forget non-regular expenses like taxes, maintenance costs, upcoming fees, etc.
4. Add up the incoming and outgoing cash separately. Then, take the opening balance, add the inflows and subtract the outflows. This is your closing balance.

Next comes analysing the forecast. Study net cash flow (inflows minus outflows) for clarity on how cash reserves went up or down. Once a forecast has been acted upon, don't forget to compare it to what actually happened during the reporting period. If the projection was incorrect, reflect upon what you miscalculated. This will ensure the next forecast is more accurate.

Neglecting cash flow projections amounts to poor cash flow management as they directly impact decision-making and budgeting.

2. Managing accounts payable

Accounts payable has a direct connection with cash flow because it represents money owed to vendors and suppliers. The company records it when it receives an invoice for goods/services bought on credit, not when it pays for the purchase. Effective accounts payable management is all about getting payment timings right. Paying too early might result in negative cash flow. But delaying payment to avoid a cash shortfall might result in additional expenses (late fees, interest, etc) and damage the relationship with suppliers.

The accounts payable department is responsible for finding a middle ground. They must understand that the account payable workflow isn't only concerned with about invoice and payment processing but also negotiating favourable payment terms with suppliers, such as early payment discounts as an incentive for prompt bill settlement.

3. Managing accounts receivable

Accounts receivable represents cash owed to a company from goods/services sold but not yet paid for. Both accounts receivable and accounts payable are found on a company's balance sheet.

Receivables contribute to positive cash flow. Failing to collect payments on time can strain a company's cash reserves and affect operations.

The accounts receivable process involves sending invoices, tracking payments, and following up with customers. Here too, setting favourable payment terms is of vital importance.

One way to optimise accounts receivable is to adopt cash flow management software that automates invoicing and payments. Clearly communicating payment terms to customers, using fast payment applications, and offering early payment discounts also helps. Such practices will not only optimise cash flow but also win the trust and loyalty of customers.

Importance of cash flow management

What makes cash flow management important is that it drives the success, survival, and growth of a business. Here are seven reasons why cash flow management should be a top business priority:

1. It helps businesses achieve financial-readiness, adequately cover operating expenses, and avert cash shortages brought on by poor cash flow management.
2. It optimises spending. Scrutinising how company money is spent helps eliminate waste and focus on revenue-generating areas.
3. It improves decisions, which are backed by authentic data and insights. Using the insights, trends, and patterns born out of strong cash flow management strategies, companies can make decisions validated by something stronger than intuition and assumptions.
4. It supports growth. With full clarity on net flows, business leaders can plan to expand the business without draining financial resources or taking on excess debt.
5. It promotes smart investments. Great cash flow management strategies not only sustain sufficient liquidity but also stop the underutilisation of funds. By scrutinising the investing cash flow section, companies can use any excess cash available to make intelligent investments that generate more money for the business.
6. Cash flow management boosts credit-worthiness. A healthy cash flow position indicates efficient financial management, helping companies attract investors and financing on their terms.
7. It makes companies future-fit. Cash flow projections guide businesses on how to cover future expenses, survive upcoming challenges, and make the most of opportunities.

Common cash flow problems

The most common causes of poor or negative cash flow are:

• Weak or fluctuating sales
• Excessive inventory, which incurs additional expenses related to storage and insurance
• High debt levels, resulting in repayment challenges
• Payment delays and late fees on account of poor payable and receivable management
• Cash shortfalls as a result of poor planning
• Over-investment in fixed assets
• Inaccurate tax filings, leading to penalties
• Idle cash, or money that isn't earning a return on investment

If not addressed in time, cash flow problems can have a significant impact on company finances and business continuity.

Cash flow management and relationship-building

Along with sustaining financial health, cash flow management plays another important role – it is the basis of long-lasting business relationships built on trust.

By paying suppliers on time, companies stand to gain better payment terms, enhanced service, and greater business opportunities. The trust you build will ensure your suppliers' cooperation even in hard times.

Fulfilling customer demands and offering secure and convenient ways to pay contributes to higher sales and timely payments. Similarly, paying salaries on time enhances employee engagement and improves performance. This is why companies must pay attention to their accounts receivable and accounts payable processes.

Businesses thrive on strong business relationships. Strong relationship-building boosts trust and loyalty, increases satisfaction, enhances collaboration, and creates a positive company culture. All of these are essential to improving cash flow.

Cash flow management and debt financing

Business often rely on external financing to improve cash flow, especially to meet big expenses associated with purchasing plants and machinery or launching new products. Debt financing helps companies maintain healthy cash reserves and avoid cash flow issues. Sometimes, it makes more sense to finance a large order than pay for it upfront. That way, your cash flow isn't depleted.

Financing has its advantages – it is tax-deductible and doesn't impact business ownership. But there are disadvantages too, such as interest payments. The idea is to pick the right option, such as a loan with a low interest rate.

Aspire can help

Given how crucial effective accounts payable and accounts receivable management is to manage money flows properly, Aspire has some useful solutions for you. Introducing our payable management and receivable management platforms, which help you to:

• Schedule payments to optimise cash flow
• Get paid at least 14 days faster on average
• Categorise revenue streams for efficient cash flow tracking
• Automate invoicing and approvals securely
• Save time with bulk payment processing
• Get your cash flow overview on a single dashboard
• Integrate seamlessly with your accounting software for flawless cash flow management.