Article Contents:
Cash Flow Management:
Many small business owners believe there’s little to worry about as long as their business is profitable. However, even a highly profitable company can face financial turmoil if cash flow management is not given priority. Poor cash flow management is one of the significant reasons businesses fail.
In this article, I offer my perspectives on why cash flow management is essential and how small business owners can implement some proven methods to make the business profitable and have excess cash when required.
The Illusion of Profitability & cash is real:
Profitability is undoubtedly essential for any business. It indicates that your products or services are in demand and that you’re operating efficiently. However, profitability alone doesn’t equate to financial stability. Here’s why: profit is often an accounting measure as revenue minus expenses, while cash flow is a real-time indicator of your business’s liquidity.
For example, one of my clients is profitable thanks to the niche segment in which they operate; however, every month, the CEO and finance head spend time together managing salary payments. Sometimes, the founder will pump in his personal money to manage the financial crisis. That is due to delayed payments from customers. I have witnessed the vendors also frequently calling the founder for their payment. Most of the time, the founder allocates and manages the cash flow to different vendors.
- Profit vs. Cash Flow: Profit is what’s left after all expenses have been deducted from revenue. But cash flow refers to the movement of money in and out of your business. Even if your business shows a healthy profit, delays in receiving payments or unexpected expenses can create a cash crunch.
Why Cash Flow Management Matters for small businesses?
Managing cash flow effectively ensures that your business can meet its obligations, invest in growth, and handle unexpected challenges. Here are some key reasons why cash flow management is vital:
- Operational Stability: Adequate cash flow keeps your day-to-day operations running smoothly. This includes paying employees, suppliers, and utility bills on time.
- Growth Opportunities: With a strong cash position, you can invest in opportunities, whether it’s purchasing new equipment or expanding your team.
- Crisis Preparedness: Businesses that manage cash flow well are better equipped to handle downturns, unexpected expenses, or emergencies. For example, during COVID-19, many small business owners struggled to run their businesses due to a lack of excess funds in the system.
How to Track and Improve Your Cash Flow?
Tracking your revenue and expenses closely is the foundation of effective cash flow management. Here’s how to stay on top of your finances, even if you don’t have a finance education background.
- Regularly Monitor Cash Flow Statements
Reviewing your cash flow statement weekly or monthly can give you a clear picture of your financial health. Look at where your money is coming from and where it’s going. Identify patterns that might indicate potential problems.
In one of my client businesses, we have introduced a process wherein the account team and CEO review the status of payables and receivables every Monday.
When was the last time you reviewed your cash flow statement in detail?
- Forecasting Future Cash Flow
Create cash flow forecasts to anticipate future financial needs. This involves predicting income and expenses over the coming months. By planning ahead, you can prepare for potential shortfalls and avoid surprises. - Manage Accounts Receivable and Payable
- Speed Up Receivables: Encourage faster payments from customers. This could be achieved through incentives for early payment or stricter payment terms. Also, regular follow-up is required with the customers. Only a few customers have a system to pay on time.
- Manage Payables Wisely: While you want to keep cash in the business for as long as possible, paying your suppliers on time is crucial to maintaining good relationships. Balance the timing of your payments to ensure liquidity.
Consider auditing your receivables today in terms of age, say more than 60 days,90 days, and 180 days, to identify any outstanding invoices and take immediate steps to speed up payments.
- Control Expenses
Review all business expenses regularly to identify areas for cost reduction. Are there unnecessary expenses draining your cash reserves? Lean operations can help maintain a steady cash flow without sacrificing quality.
Are there recurring expenses in your business that you haven’t evaluated in a while?
In most of my client’s operations, we have a process for reviewing the P&L before the 10th of every month and identifying any abnormality in the expense pattern.
- Establish a Cash Reserve
Building a cash reserve acts as a financial safety net. It supports your business through lean times or unexpected crises, providing stability and peace of mind.
I suggest keeping 6 months’ expenses for materials and operating expenses as a cash reserve. One of my clients keeps this emergency reserve in the form of a Liquid mutual fund; whenever he needs the cash, he uses it to redeem the reserve, which is the safest and most brilliant way of getting returns from your excess cash.
Areas for Improvement in Cash Flow Management
- Inventory Management Optimization:
Excess inventory in RM +WIP+FG can quickly drain your cash reserves, especially if it remains unsold for long periods. Here are strategies to manage this more efficiently:
- Strictly follow min/max inventory norms: Consider adopting a JIT approach to reduce carrying costs. Only order inventory as needed based on current demand forecasts. It can be monitored by fixing Min / Max inventory levels, and once in a quarter, those levels can be revisited and changed.
- Analyse Inventory Turnover Ratios: Calculate how quickly your inventory is being sold and replenished. If certain products have low turnover, evaluate whether to discontinue or discount them to free up cash.
- Negotiate with Suppliers: Work with suppliers to arrange more favorable payment terms or even consignment stock agreements, where you only pay for inventory once it’s sold. Also, working with suppliers to reduce lead time and MOQ will help to reduce unnecessary inventory due to long lead time and high MOQ.
Please take a moment to review your inventory turnover rates today and identify any items that are draining your capital.
- Supplier and Vendor Negotiations
Reducing the cost of supplies and services can lead to significant savings over time.
- Renegotiate Contracts Annually: Review contracts with vendors and suppliers regularly to identify opportunities for better terms. Use your business’s loyalty or volume as leverage to secure discounts or extended payment terms.
- Seek Multiple Quotes from many suppliers: Don’t hesitate to request quotes from multiple suppliers for major purchases. The competition may lead to more favorable pricing.
- Operational Efficiency
Small businesses can benefit from streamlining operations to reduce waste and unnecessary expenses.
- Invest in Automation: Where possible, automate repetitive tasks like invoice processing, payroll, and customer service. Automation in manufacturing should be implemented wherever possible to reduce labor costs. Although there may be an upfront investment, automation can significantly reduce labor costs.
- Improve the flow: Invest your time in improving material flow, capacity balancing, and cycle time reduction initiatives to reduce working hours and overtime.
- Energy Efficiency: Review your utility expenses and look for energy-saving measures. These could include upgrading to energy-efficient machines, reducing the production cycle time and lighting, and optimizing heating and cooling systems.
- Review and Reduce Fixed Expenses
Fixed expenses, such as rent, utilities, and salaries, can take up much of your cash flow.
- Outsource Non-Core Activities: Evaluate if there are areas of your business, like accounting or marketing, that could be outsourced at a lower cost than hiring in-house staff. Outsourcing can also provide access to specialized expertise.
- Downsize or Consolidate: For businesses with multiple locations or facilities, consider consolidating operations into fewer spaces. This can reduce rent, utilities, and maintenance costs.
- Leverage Digital Marketing: Digital platforms like social media, email marketing, and content marketing are often more affordable and can be highly targeted. Analyze your marketing channels’ performance and reallocate the budget to those delivering the highest ROI.
Audit your current admin expenses and look for opportunities to reduce the expenses.
- Debt Management and Interest Expense Reduction
One of my client’s businesses has a healthy gross margin, but its net margin is negative thanks to high debt and bank interest payments. High-interest debt can be a cash flow killer.
- Refinance Loans: If you have existing loans, consider refinancing at a lower interest rate. This can reduce monthly payments and free up cash.
- Debt Repayment Strategies: Prioritize paying down high-interest debts quickly.
- Negotiate Payment Terms with Lenders: If cash flow is tight, speak to your lenders about extending payment terms or temporarily reducing payments.
To sum up,
While profitability is important, cash flow is the lifeblood of your business. You can ensure long-term financial stability and avoid potential pitfalls by diligently tracking revenue and expenses, reviewing cash flow processes, and implementing strategic improvements. Remember, a proactive approach to cash flow management today can protect your business from failure tomorrow.
What steps will you take today to improve your business cash flow?
