Improving your cash flow

Cash flow management is critical for any business or organization, especially those in growth mode. Even when profitable, poor cash flow management can lead to a disastrous outcome for a company. If your business has ongoing cash flow issues or if you suddenly find yourself short of cash, there are steps you can take to assess and improve the situation.

Cash Flow vs. Profit 

Cash flow is the movement of cash in and out of a business. There are three categories of cash flow: 

• Operating cash flow is the cash generated by a business's day-to-day operations. It includes cash from sales, receivables, and payments to suppliers and employees. 
• Investing cash flow is the cash used to purchase long-term assets, such as property or equipment. 
• Financing cash flow is the cash related to debt such as loans or credit card debt and equity such as new investment and return of capital. 

Cash flow is the net inflows and outflows from operating, investing, and financing activities. On the other hand, profit, or net income, is what a business earns after subtracting expenses from revenue. 

One would expect a profitable company to have positive cash flow, but that's not always the case. For example, a company may have had revenue of $100K last month, but customers were slow to pay, which caused a cash-flow deficit. Or, a company had to purchase a considerable amount of inventory to gain lower pricing and increase profitability, but it caused a cash shortage. Of course, there are many reasons why a profitable (and unprofitable) company may become short on cash.  

Get Current on Financials

It's difficult at best to manage a problem without timely and accurate information. A company should update all financials, including the income statement, cash flow statement, and balance sheet. 

Review assets, liabilities, and corresponding schedules. For example:

• Review the accounts receivable and identify the amount of current, overdue, and uncollectable receivables. 
• Review inventory and assess what is good versus what may have spoiled or is no longer usable.  
• Review prepaid expenses and amortized assets to make sure they are accurate.

Taking a detailed look at your financials will provide the data necessary to identify the root causes of many problems. 

Create Projections

While the income statement, cash flow statement, and balance sheet provide a current and historical view of a business, they don't project into the future. Financial projections should be created using a spreadsheet or specialized software and include an Income Statement, Statement of Cash Flow, and Balance sheet. The financial model should be driven by key variables so the business can test a variety of future scenarios. 

Projections will provide visibility into what might happen under various scenarios and enable management to select the best path forward.  

Improving Profitability

A company's net income is a significant factor in cash flow. If a company is profitable, cash flow is easier to manage because it typically has the assets to support financing. However, if a company has not reached profitability or has become unprofitable, financing cash flow deficits can be more challenging. 

Cash flow problems call for a critical look at the income statement. A company may have a problem with sales, expenses, or both. All too often, a company's costs get out of alignment with its revenue. Perhaps sales have trended downward over several months without any adjustment to expenses. Maybe the company has personnel that are no longer needed. Maybe the company has experienced increases in the cost of goods sold due to inflation but has not increased the price of its products or services. 

Challenging business situations often help an owner make the tough decisions in cutting expenses or making other changes that ultimately strengthen the business. In most cases, improving profitability is a first step to alleviating cash flow issues. 

Improving Cash Flow

While improving revenue and expenses may help cash flow, there are several other steps a company can take to alleviate cash flow challenges. Below are examples of operational and financial tactics a company can employ.

Collections. Accounts receivables may be an opportunity to increase cash quickly. An aging report will provide insight into the effectiveness of collections activity. A high amount of non-current receivables is typically the result of poor collections activity or problems with the product. Focusing on collections may be a quick win for building cash.  

Customer Deposits. Is there the ability to collect a customer deposit with a new order? If a business must purchase and hold inventory to build the final product, collecting a customer deposit may help offset the cost of holding inventory. If a customer deposit is not possible, a signed purchase order can be just as valuable; financial institutions will often lend against purchase orders.

Time to Invoice. Once the product is delivered, how long does it take to invoice the customer? Each day lost waiting to invoice is a day lost to receiving payment. Be sure to invoice as soon as possible.

Customer Terms. Extending generous terms can cause serious cash flow problems, especially if customers still pay late. While there is the potential to receive financing based on receivables, it may be wise to tighten the terms extended to customers.  

Payment Discounts. Offering discounts for early payment or prepayment can help improve cash flow. Subscription-based companies often provide a 10% discount to prepay for semi-annual or annual services. It not only locks the customer into the service but provides significant upfront cash to the business.  

Ease of Payment. Make it easy for the customer to pay you. Providing payment options such as credit card, ACH, or wire transfer can help speed the payment process. Even though a business may pay credit card fees, the process is typically faster than waiting for a check by mail.  

Vendor Terms. Negotiate longer terms with suppliers, especially if customers are demanding longer terms.

Credit Card. Applying for a corporate credit card may help bridge the gap for smaller cash flow issues. Additionally, the company can gain points and other benefits from using the card for all purchases.  

Line of Credit. Consider opening a line of credit with your bank or other financial institution. Lines are often based on collateral such as accounts receivable and inventory, and can be expanded as you grow and establish a successful payment history. Commercial lines of credit typically take weeks or months to set up so take action well in advance of cash needs. 

Equity Investment. Startups and growing companies often sell equity to raise funds for growth. Mature companies can also sell equity to pay down expensive debt, provide liquidity or recapitalize ownership.

The above are just some of the many ways a company can improve its cash flow position. Planning is one of the best ways to prevent cash flow issues, but sometimes cash flow issues arise quickly and unexpectedly. Every business is unique, and thus, it's important to meet with one of our expert advisors to help with your specific situation. Contact our office if you'd like to discuss your situation and how we may be of service.