8 Tips for Maximising Cash Flow
Boost money on hand and reduce stress through cash management
Liquidity is the ultimate goal of working capital management, and the ultimate proof of liquidity is positive cash flow. Thus, maximising cash flow is really maximising the working capital of a business.
In turn, maximising cash flow hinges on maximising inflow components and minimising outflow components.
Definition: Cash Flow
Cash Flow refers to the net amount of cash and cash equivalents being transferred in and out of a company. Cash received represents inflows, while money spent represents outflows.
Definition adapted from Investopedia.
Profit vs Cash Flow
Profit and Cash Flow are often confused by business owners, generally because it’s assumed that a business that makes money (i.e, is profitable) also generates positive Cash Flow. This lack of understanding leads to a focus on improving sales and profit margins, which usually makes the problem worse.
As explored in the definition above, Cash Flow is the net cash that flows in or out of a company, over a period of time.
Profit, on the other hand, is defined as the value that remains when a business’s expenses are subtracted from its revenue (sales).
It is possible to make a profit, but have an outflow of cash. The opposite is also true, where it is possible to make a loss, but have an inflow of cash.
If you refer to the graph below, you can see the steps where this business has made a substantial profit, but has had negative cash flow:
$1,000,000 Cash in from Sales
$700,000 Cash out on Expenses
This leaves a Profit of $300,000
We then have an $84,000 income tax payment due for a previous trading period, that is not accounted for as an expense
The principal of the company’s loan is $31,000. Only the interest portion appears on the profit and loss statement as an expense
A further $210,000 was invested into machinery, which is seen as an asset purchase rather than an expense
The result is a Negative $25,000 Cash Flow.
An example of a Business with a $300,000 Net Profit but a $25,000 Negative Cash Flow
Maximising inflow and minimising outflow
The basic ways of accomplishing the task are:
Identify the inflows
Determine ways inflows can be maximised
Identify the outflows
Determine how outflows can be minimised
There are, however, five principles that the business should keep in mind before proceeding with the foregoing tasks.
1. Extended Action
Activities performed in the business actually take longer — and accordingly cost more — than what have been committed on paper in the planning stage, even assuming that a liberal planning scenario was used.
Given this principle, the business must always give allowances for unanticipated cash outflows in order not to be caught flat-footed when they occur.
Examples:
The production department may suddenly find itself confronted with a sharp rise in raw materials cost, or a need for sophisticated and costly equipment unexpectedly crops up in the course of finding ways to meet customer demand.
Circumstances may develop that would compel the business to direct the sales department to reduce the number of its people drastically, resulting in reduced productivity and training cost overruns to compensate for the effect of reduced manpower.
The marketing department may need to conduct unplanned research in the face of new developments in the competition that the company had not recognised previously.
3. The cash drain resulting from these examples may leave the business with no resources to meet the demand for its products, causing it to suffer opportunity loss.
2. Sustained Adequacy
Cash flow must be adequate at all times. The moment this simple precept is neglected, the possibility of financial collapse hangs like the sword of Damocles.
This is the controlling principle in all efforts to develop strategies for keeping the company’s cash position in top shape.
Sometimes business people tend to get carried away by their ideas and the opportunities those ideas may open up, and go into a spending spree without checking the consequences on cash flow. To keep the business afloat, this tendency should be avoided.
3. Protecting Employee Pay
Many businesses still don’t realise that payroll is their top financial priority because their people are their most precious assets.
In a cost-cutting scenario, payroll should be a last resort, if ever. Deciding otherwise is like taking employees for granted. This could result to costly loss of morale, not to mention the possibility of employees leaving the company.
Some experts believe that the secret to successful cash flow management in times of crisis is to know where a business can cut costs, and employee salaries and benefits is one area that is best left alone.
4. Inevitability of Taxes
The government is one creditor a business cannot afford to shy away from. Unlike employees, the government does not go away if the company attempts to avoid paying its taxes.
Tax payment should not be an option in a belt-tightening program.
If the company neglects tax payment, it risks incurring financial penalties and even possible punitive action by the government. Government should be regarded as one of the company's top creditors and treated with utmost respect.
5. Preservation of Owner’s Interest
The business must satisfy first the debts personally guaranteed by the owners. In the event of bankruptcy, owners should be spared from personal liability.
Tips for Maximising Cash Flow
1. Set up a cash flow management system that works for the business
For a service-oriented business, the system may be relatively simpler compared to a non-service one, and a spreadsheet-based solution with a number of “what-if” scenarios contained in it may suffice.
However, for a manufacturing or wholesale/retail business, the system might be a little more complex because cash flow has to consider inventory management. Here, the focus of the business is to keep inventory moving so that it can be converted to cash in the shortest possible time.
Preparing a monthly cash flow forecast helps the business plot the volume, timing and pricing of inventory disposal over a one-year period. It also helps in making future adjustments in the forecast once actual figures become available.
2. Know how to make a projected cash flow
Projecting business cash flow into the future is something the company should know how to do. This is the cash flow forecast. When the company has a cash flow projection, it has a clear idea of when cash is expected to come, and in what amount, based on the company’s experience with suppliers’ delivery methods, customers’ ordering pattern, and the seasonality of the product.
The first item to enter on the projected cash flow sheet is the amount of cash on hand, which consists of the current bank account balances plus actual currency and coins in the company cashier’s possession.
After the current cash balance, the anticipated inflows in the next 12 months are listed down. These usually include: cash sales and collection of payment on credit sales. In projecting cash inflows, the business is better off using the accounting principle of conservatism: estimate a lower amount and a longer date of arrival
The next items for inclusion are expected outflows in the next 12 months: payroll, payments on accounts payable, payments on debts guaranteed by the owners, taxes payable or reserved for future payment, monthly overhead, marketing expenses, other operating expenses, and equipment purchases
All cash flow items are to be arranged in chronological order in a spreadsheet. If a negative cash balance shows in the bottom line, a potential problem exists. However, it also gives the business the opportunity to address the problem before it actually happens
If a positive cash balance results, the business can be optimistic about covering unanticipated cash needs in the future. The company can also determine in advance how to invest cash surplus for future growth.
The business cash flow projection allows the business to draw up strategies to strive for the highest possible positive bottom line. This is where the maximisation effort begins.
3. Keep tabs on actual cash flow
As the months roll on, the business should monitor and track actual cash flow, comparing it to the forecast in order to make adjustments in case something was overlooked in the planning.
4. Focus on customer management
Sales are the biggest and most significant cash inflow item. If the business can maximise sales, it can maximise cash flow. Customer management should address:
Attracting quality customers, especially if most of the sales is on credit
Innovating ways to generate repeat orders from customers
Prompt invoicing, coupled with use of pre-addressed, stamped remittance envelopes
Encouraging customers to pay by credit card (credit card sales convert to cash in a matter of days)
5. Promptly follow up on late invoices
To prevent accounts from getting sour later, the business should develop the habit of reminding customers immediately when late payments crop up.
When late payment persists, a written notice should follow the phoned up reminders.
If the delinquency becomes intolerable, it should be referred at once to an attorney or to a collection agency to help speed its conversion to cash.
6. Be aware of bank and online credit facilities clearance times & fees
Clearance times often differ, even though a sale has been made or a payment has been processed in some instances this could take a few days to clear depending on your provider. Different banks and online credit facilities also charge different fees.
Negotiate with your Account Manager for the shortest payment times and the lowest fees.
7. Minimise inventory costs (for non-service businesses)
Inventory lying idle means no cash flow, and it is a cost item. To avoid this situation, the business can do several things:
Maintain only enough inventories to meet anticipated sales
Monitor inventories constantly to ensure that they keep moving
Make a forecast of inventory as accurately as possible to avoid excesses
When inventory includes many items, concentrate on the ones that account for 80% of sales
Try to order as late as possible. Once ordered, determine how to get it the fastest way
Shop around for competitive prices to keep inventory costs down
Have a policy on obsolete inventory that speeds up its conversion to cash
8. Take advantage of short-term financing
Short-term financing is good when it can be used to avail of opportunities to expand the business and generate even greater cash flow. A good source of this type of financing is a credit line.
It is advisable to have a credit line well in advance of its actual need so that when the need arises, the funds are ready for draw-down.
Having a credit line is also one way of maintaining good relations with a lender.
