Managing cash flow is like having the perfect baseball swing: it’s all about timing.
Money flows into and out of your business on a daily basis, as you get payments from customers and settle bills with suppliers and staff. Then there are the overheads, and taxes, and a thousand other payments to keep track of.
Timing is important because even if your business is profitable, you can run into problems if the payments from customers come in too slowly, and you have too many outflows while you’re waiting for the check that you’ve been promised that is in the mail. This is particularly critical for small businesses, which often have small reserves of cash and credit to fall back on.
So in this tutorial, we’ll explore cash flow in detail, and give you some tools to help you forecast your cash flows accurately for the next 90 days. Then we’ll give some practical tips on improving your company’s cash flow, either by speeding up the inflows or slowing down the outflows.
By the end of this tutorial, you’ll understand why the timing of cash flows is so important to a business. You’ll be able to manage and forecast cash flow effectively, and will know what steps to take if cash starts to run short.
1. What is Cash Flow?
First of all, let’s get clear on what cash flow is.
Cash flow simply refers to the way a business receives money and pays it out. Whereas profit looks at when a sale was made or an expense was incurred, cash flow looks at when the company actually received the money or paid it out. The two can be quite different, as we’ll see later on.
In a previous tutorial, we looked at the cash flow statement, and saw that it was a summary of all the flows of cash over the course of a year.
But a year is a long time in business. Even if a company has a positive cash flow over the year, it could face the business equivalent of those months where the fridge needs replacing, the mortgage is due, and there’s a delay receiving your paycheck. So in this tutorial, we’re going to look in more detail at the ebb and flow of cash over shorter periods.
2. How to Forecast Cash Flows
If you want to understand something and manage it effectively, you first have to measure it. In the cash flow world, that means keeping track of your current cash balance, and forecasting all the money you expect to receive and everything you’ll have to pay out in the coming weeks and months. Not having a regularly updated cash flow forecast is the business equivalent of flying blind.
Fortunately, keeping track of your cash flows is not difficult. It’s quite similar to what you do with your own personal finances every month, working out when your salary will come in and when the credit-card payment is due, and making sure you have enough in your account at all times. Business accounts tend to be more complicated, and cash flows can be more unpredictable, but the basic principle is the same.
There are tools to help you as well. Small-business accounting software like QuickBooks has cash flow forecasting built in, or you can use specialized cash flow management applications like Pulse, Float or PlanGuru.
If you don’t want to invest in dedicated software, an Excel spreadsheet will also do the job. Microsoft Excel has included a cash flow forecasting template in all versions from 2007 onwards. Other templates are available online, for example this Excel template from the business education nonprofit SCORE.
Here’s a cash flow forecast for a fictional company, CoolGadget Corp., adapted from the template that comes bundled with Excel. You can also download this example as a spreadsheet.
As you can see, CoolGadget plans to start the month of February with $5,000 in its account, but will have a slim positive balance of just $1,000 at month end. As we read down into the details, we can see why. The company expects to receive $15,000 during the month, but pay out $19,000.
We then take that $1,000 balance and see what will happen to it in March, and then in April. In March, the cash receipts are slightly higher than the money paid out, so the cash balance inches up to $1,250. But in April, the company will drop into the red. Its sales are rising, but a planned advertising spend of $5,000 is more than the company can afford right now.
That’s why cash flow forecasting is important. Companies can run into trouble even when sales are rising, simply because they can’t afford the investments. CoolGadget needs to delay some of that spending, or try to get the money coming in faster.
It might also be necessary for the company to start forecasting on a weekly or even daily basis, because even in February and March it’s sailing very close to the wind. It ends the month with a slim positive balance, but if the timing of the payments isn’t favorable, it could dip into the red during the course of the month.
If you find yourself needing to forecast more frequently, you can use the same basic template, and just change the headings at the top from months to weeks. The template we’ve used allows for monthly planning for the next 12 months, but you could easily change that to weekly planning for the next 12 weeks. You can also change the categories down the side to whatever makes the most sense for your business.
Generally, the more precarious your cash position, the more detailed your forecasts should be. It’s the same as with personal finances: if you’re struggling to make ends meet, you have to budget for every trip to the supermarket, whereas when you have a healthier bank balance you can afford to be a little more hands-off.
3. Tips for Improving Cash Flow
So what can you do if, like CoolGadget, you see that dreaded splash of red ink on the cash flow forecast?
Remember, it’s all about timing. If a business has healthy sales and profit but poor cash flow, it’s generally because the timing is off, and money is going out faster than it’s coming in. To improve cash flow, you either need to get payments coming in more quickly, or delay paying money out.
Let’s look at some practical ways of doing that.
Speed Up the Inflows
Companies make sales in different ways, so how you handle this depends on your business model. A consumer-facing business like a restaurant or café takes payment from customers immediately, so to take money in faster it needs to increase sales, perhaps by offering a special limited-time promotion.
But many businesses don’t get immediate payment from their customers. That’s particularly the case for business to business transactions. CoolGadget, for example, doesn’t sell directly to consumers. Instead it sends a crate of gadgets to an electronics wholesaler, and that company will send payment within an agreed amount of time, like 30 days.
And that’s where the problem comes in for many businesses. A 2012 survey by the National Federation of Independent Business showed that 64% of small businesses had invoices that had gone unpaid for at least 60 days. These delays can really hurt a company’s cash flow.
In this case, the most effective way of improving cash flow is by collecting money faster. You can do this in a number of ways:
A. Better Invoicing
Many small businesses view invoicing as a tedious administrative task, but getting it right is a key component of success. You need to send out an invoice immediately after you’ve supplied the goods, and include all the necessary information, especially payment terms such as what late fees and interest you’ll charge, and a prominent due date.
Sending out accurate invoices as early as possible is a straightforward way of improving a business’s cash flow. QuickBooks, the accounting software mentioned earlier, includes an invoicing function, or you could try an online service like FreshBooks or Invoicely.
B. Contact Late-Paying Customers
This can be tricky, because you want to have good relationships with your clients. But if a payment is due, it's best to be polite but firm. Send a new invoice, including late fees and interest. Call and check that the invoice was received, and ask whether anything is unclear. Keep a friendly tone, but don’t hang up until you get an agreed payment date, which you can then confirm by email or in writing.
C. Renegotiate Payment Terms
Ideally, you want to negotiate payment terms with your customers that are at least equal to, and preferably shorter than those you have with your suppliers. For example, if you have to settle your bills within 30 days, you want your customers to pay within 30 days too, or perhaps even less. You certainly don’t want to be making payments within 30 days, and receiving them in 45 days.
It can be tricky for small businesses, especially when dealing with larger companies that have a stronger bargaining position. But you can start by being clear about what your terms are, and paying attention to the wording of contracts and invoices. There’s some helpful advice on payment terms in this UK government fact sheet.
Slow Down the Outflows
As well as making payments come in more quickly, another way to maximize your cash flow is to slow down the outflows. Here are some options:
A. Delay Investments
If your business is doing well, it’s tempting to invest in new equipment or marketing in an attempt to boost growth even more. But sometimes even an investment that would be profitable in the long-term can cripple a business in the short term.
With our CoolGadget example, it was a $5,000 advertising payment that tipped the company over into the red. Although that advertisement would probably bring in more sales and be good for the long-term health of the company, it needs to be delayed for a month or two, until the company has enough cash to cover the spending.
B. Renegotiate Terms
Just as you renegotiated with your customers, you can also try it with suppliers. See if you can get them to agree to a longer payment window, say 45 days instead of 30. That could be just the cash cushion your business needs.
Even if you can’t get an extension, you can make sure you’re taking as long as possible to pay. You need to be careful here, because you don’t want to breach any deadlines that you’ve agreed with suppliers. That puts them in cash flow difficulties of their own, and is bad for your reputation. And you certainly want to make sure you always pay your staff on time.
But if you’ve been given 30 days to pay for some goods, take the full 30 days. Allow that money to sit in your account for as long as possible, giving you more of a safety net in case you have other unexpected expenses.
C. Minimize Inventory
With our fictional company CoolGadget, we discovered from its balance sheet that it had $100,000 in inventory. That’s $100,000-worth of unsold gadgets just sitting in its warehouse.
A more efficient way of managing cash flow is to keep inventory to a minimum. You want enough to satisfy demand, but no more. If CoolGadget had built up a more reasonable inventory of $20,000, it would have been left with an additional $80,000 to cover its other expenses, and its cash flow would be more healthy.
Companies with cash flow difficulties may find it difficult to borrow money, but it’s worth exploring any possibilities. Even if you can’t borrow more, it might be possible to refinance existing debt to longer terms with lower payments.
If you can negotiate a line of credit or even a bank overdraft with reasonable interest rates, that can give you some extra flexibility in the months where you suffer an unexpected expense, or your major customer delays payment.
4. Striking the Right Balance
With all of these cash flow management techniques, it’s important to balance the short-term and long-term needs of your company.
To ensure short-term health, the best ploy would be to have a huge cash balance sitting in your account, along with loans and credit lines just in case.
But that could be a long-term drag on the growth of your business. The excess cash could often be put to better use, for example by investing in new equipment for your business, spending money on advertising and marketing, or paying down debt.
Learning to forecast cash flows accurately and manage them efficiently helps you to maintain the right amount of cash at all times. Using the forecasting tools you’ve learned about in this tutorial, you can see when you can afford to invest in your business, and when you need to be more cautious. You can play with the assumptions, seeing what would happen under a “worst case” scenario. More importantly, you can take steps to avert a possible cash flow problem, before it becomes a crisis that threatens your business’s future.
By managing cash flow efficiently, you can strike the right balance between the short term and the long term. You can feel confident investing money in the future, because you know you’ve also kept enough cash on hand to manage the short-term ups and downs.
Editorial Note: This content was originally published in 2014. We're sharing it again because our editors have determined that this information is still accurate and relevant.