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Why is good cash flow management important?

By September 7, 2011April 15th, 2019Popular

Cash flow is the lifeblood of small businesses. Cash comes from sales, collections of account receivables, and the sale of assets. On the other hand, cash flows out to meet all expenses and debt obligations of the business.

cash-flow1The goal of good cash flow management is to have enough cash on hand when you need it. This is a simple concept, yet in practice, eludes even the biggest operations. So long as more money seems to be coming into the business than going out, many small business owners do not give cash management a second thought. And that leaves them vulnerable to all kinds of cash-flow dangers.

Learning good cash flow techniques ensures that the company always has enough cash to meet its legal obligations. Adequate cash helps obtain whatever funds are required from external sources at the right time, in the right form, and on the best possible terms. A shortage of cash flow could result in the loss of valuable trade discounts or, in extreme circumstances, financial embarrassment and bankruptcy.

Your business can increase cash reserves in a number of ways.

Collecting receivables. Many small businesses can improve their cash position simply by making certain that their billing, collections, and payables systems are operating as efficiently as possible. Small businesses do not have the luxury of large accounting and collection departments of big corporations. More so if you are a home-based entrepreneur working solo! First, get your customers to pay you as soon as possible! To the extent possible, adopt the business practice of requiring up-front deposits when making sales. If your service is regular, consider collecting your money on debit order. You are immediately alerted when your customer is not in a good financial standing. You are able to stop service, product deliveries etc avoiding huge losses. However, if the account payment is a receivable, then make sure that you actively manage its collection by billing promptly, aggressively following-up on overdue invoices, and quickly collecting on overdue accounts. You stand to lose revenues if your collection policies are not aggressive. The longer your customer’s balance remains unpaid, the less likely it is that you will receive full payment. Remember by collecting by debit order, you are in control of your cash-flow and will be taken more seriously, treating you as a priority. Negative information is recorded immediately with the financial institution creating unnecessary costs and embarrassment.

Tightening credit requirements. If you think that you offer the best product or service relative to your competitor, you can obtain the best possible credit conditions. Be sure to tell your potential customers upfront your credit terms – before you provide your product or service. To improve your cash flow position, you can be more stringent in your credit and terms, requiring more customers to pay cash for their purchases. This will increase the cash on hand and reduce the bad-debt expense. However, there are trade-offs to tightening credit in the short and in the long run. Looser credit allows more customers the opportunity to purchase your products or services. You should measure, however, any consequent increase in sales against a possible increase in bad-debt expenses. Another way is to get as much information from the client as you can in the form of “customer questionnaire.” The more information you have about the customer, the easier for your payment collection process in the event the person rescinds on the payment.

Taking out short-term loans: Loans from various financial institutions are often necessary for covering short-term cash-flow problems. Revolving credit lines and equity loans are types of credit used in this situation.

Increase salesIncreasing your sales. Increased sales would appear to increase cash flow. However, if large portions of your sales are made on credit, when sales increase, your accounts receivable increase, not your cash. Meanwhile, inventory is depleted and must be replaced. Because receivables usually will not be collected until 30 days after sales, a substantial increase in sales can quickly deplete your firm’s cash reserves.

Managing your payables. A key strategy in cash flow management is to aim to bring cash into the company as quickly as possible, then hold onto your cash as long as possible by managing your payables. That means, quite simply, take as long as you’re allowed-without incurring late fees or interest charges-to pay your company’s bills. Remember that a bad credit history can stifle your business, so you need to protect yours. Know which vendor you need to pay first. Better yet, negotiate with some of your vendors to extend to your business liberal payment terms.

Investing your spare cash. If your cash flow has become stable and predictable, you can consider investing your excess cash. This is also applicable if you raise a large sum from angel investors or venture capitalists and you will not need to spend it all quickly. You can earn additional interest income, as well as have the necessary cash to dip into during tough times. 

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