A Small Business Guide to Managing Cash Flow

We’ve all heard the phrase that cash flow is the lifeblood of a small business, but it can also be hard to calculate, forecast and manage. So, what exactly is cash flow, how do you calculate it, and why is it so crucial to the success of a business?

**What is cash flow?

Cash flow is the money that moves in and out of your business over a given period of time. When you have positive cash flow, you have more cash coming into your business than leaving it, whereas the opposite is true with a negative cash flow.

When assessing cashflow, there are two key financial documents to be aware of, the forward-looking cashflow forecast and the backward-looking cashflow statement. 

While a cashflow forecast will plot upcoming income and expenses to predict how much money a business will have in the future, a cashflow statement reviews the past month, quarter, or year to show how cash was generated and how it was spent. Combined, these documents will help you to see whether your cashflows are sustainable.

**What affects cash flow?

When it comes to cash flow, three main areas will have an impact. Firstly, your operations are how much money you make from selling your products and services minus the expenses of delivering them. Next up is any investments you make, particularly expensive items such as property or equipment. Finally, finance such as loans, shareholder investments and dividend payments will also impact your cash flow.

**Why is managing cash flow important?

Quite simply, any business needs good cash flow to ensure it can cover its bills and continue trading. If your forecasts tell you the business is in good shape, it will relieve some of the stress and uncertainty of running a small business. It could also highlight opportunities to invest if your cash flow is positive and you have money available to spend.

Just as important, however, is that if you’re properly managing your cash flow, you’ll be able to identify any potential periods of negative cash flow and plan accordingly. Even profitable businesses can experience cash flow problems if they’re hit with badly timed costs, but by creating a forecast, you will be able to pinpoint any times when shortfalls in cash look likely to occur and either reduce spending, negotiate new payment terms of source additional funds, such as a loan, to ensure you can continue to cover your expenses. 

Managing cash flow can also help you be more flexible when handling change, such as a slow-paying client, the loss of a major customer or a general downturn in demand for your products or services. 

**How to manage cash flow

The benefits of cash flow management are clear, but how do you put this into practice? Unfortunately, there’s no one-size-fits-all when it comes to managing cash flow, as best practice will depend on the unique circumstances of your business. However, there are a few relatively simple steps to place yourself in a stronger position.

Creating and maintaining a cash flow forecast is top of the to-do list regarding cash flow management. This will give you much-needed clarity when predicting the cash coming into and out of your business over the next 12 months. When doing this, remember to factor in key expenses such as wages, materials, rent – and any increases to these that may happen – and smaller costs such as insurance, interest payments, etc. You’ll also need to predict your sales revenue. Basing this on the previous year’s figure is an excellent place to start, but remember to adjust for any seasonal variations or up/downturns due to changing trading environments.

Combining this with recording actual income and expenditure will help you to identify any major discrepancies and correct any inaccurate assumptions you may have made. Accounting software will benefit here, offering an accurate, simple way to record incomings and outgoings and enabling you to create real-time reports that you can be confident are correct so you can be clear on the current state of your finances and compare it across periods.

It’s also important to remember that cash flow management is an ongoing process, so regularly checking your current status, reviewing costs and assessing your assets is all good practice and will help you to understand your business better.

**How to improve your cash flow

Having a robust payment policy in place, including a system for chasing unpaid invoices, is a key step in improving cash flow. Accounting software that offers automated invoicing and follow-ups can again be a huge time-saver here, meaning you don’t have to remember when invoices are overdue and manually chase the client. Other elements of the policy could include:

• Timely invoicing.
• Agreeing clear payment terms.
• Running credit checks on potential new customers and building relationships with finance departments so you’re on good terms if issues arise.

Just as you need to manage the money coming into your business, so you need to be aware of your outgoings, too. Tips to improve cashflow could include looking at your expenses to see if you can cut unnecessary costs and looking for ways to manage your payables more effectively, such as scheduling payments when cashflow won’t be negatively impacted. Keeping on good terms with lenders and suppliers is also worthwhile, as it could help you negotiate more flexible payment terms if they’re ever needed.

Effective inventory management also has a role to play in cashflow control. While you’ll want to have enough stock to meet your clients’ needs, holding too much, paying for storage, and having cash tied up in product isn’t ideal. Again, forecasting is critical to striking the right balance.