Cash Flow Management: What It Is and Why It Matters

What Is Cash Flow Management?

Cash flow management is a way for businesses to analyze and control the money that's coming into and going out of a business. The goal is to predict cash flow needs with the best information possible. To create proper forecasts, you need a good system for monitoring and analyzing cash flow via this management system.

Managing cash flow means keeping track of the net amount of cash receipts daily while subtracting the expenses. This provides insight on your business working capital and where you can invest without hindering profits. Understanding the business' cash flow means you can ensure there's enough money for payroll and paying off business expenses and debts.

3 Types of Cash Flow Management

There are three types of cash flow that flow through and come from different parts of an organization.

Cash Flows from Financing (CFF)

The cash flows from financing are the net flows of cash that a business uses to fund working capital as well as the business. Some of the ways businesses use CFF are to pay dividends and issue equity or debt. If the company has investors, CFF shows the company's ability to manage the capital structure.

Cash Flows from Operations (CFO)

Your daily operations consist of producing and selling goods, and CFO comes from these transactions. When looking at this figure, you have a better idea of the funds coming in that help with the company's operating expenses and various bills. For long-term viability, a business should have more CFO inflows than outflows.

Cash Flows from Investing (CFI)

Cash flows from investing show how much a business profits from different investments. The investments may be from activities like purchasing new equipment, investing in securities, and selling assets or securities.

Why Cash Flow Management Matters

No business wants to spend more money than it's making, and this is one of the primary reasons that cash flow management is so important to businesses of all sizes.

“Without good management of your cash flow, your business is on shaky ground,” says Stefan Campbell, owner of The Small Business Blog. “With a good system, you can more easily know who needs to be paid and when. When you need to order products, you'll know exactly how much you have allotted. A good system serves as a guide to monitor spending.”

Poor cash flow management is a common mistake for small businesses. According to the National Federation of Independent Business (NFIB), cash flow is why many small businesses fail. A solid cash flow management system allows you to properly monitor and analyze your inflows and outflows to make good business decisions and help your business thrive.

Accounts Payable and Cash Flow Management

To maintain good cash flow management, accounts payable need to be on top of payments of liabilities. Within your cash flow management system, accounts payable represent how much money the business owes to different vendors, and it's important to time these payments properly.

A primary example is when a company has a cash flow shortage while it owes money to vendors. In instances like this, accounts payable may want to delay payments, but you'll need to weigh it against the potential drawbacks. Delaying payments can harm relationships with vendors and also result in late fees.

In some cases, businesses pay vendors too quickly, negatively impacting cash flow. By managing accounts payable, businesses can find the best timing that works for them while avoiding cash flow issues.

Using Automation for AP and Cash Flow Management

Automating accounts payable may help your cash flow management. Here are some ways automation can help with accounts payable and cash flow management:

• Reduce errors: Humans are prone to errors, so automation can help minimize potential mistakes when set up correctly.

• Processing invoices faster: With an automated invoice system for vendors, vendors can get paid faster. This not only helps to avoid late fees but it strengthens the relationship with vendors.

• Saving time and money: There are various costs associated with manual processes involved with accounts payable. Printing and storing data takes money and space, but an automated process uses digital software to save time and money.

• Better visibility: Using automated programs to help with accounts payable can also give you access to the status of payments so the business can make better cash flow decisions.

There may even be AI tools for your small business to help find the best timing for the payments.

6 Common Cash Flow Management Challenges

When dealing with cash flow, there are various challenges that a business can encounter. Below, we go over some of the most common challenges.

1. Accounts Payable

As mentioned earlier, accounts payable plays a key role in cash flow management. It's important to find the balance between paying vendors on time and delaying payments. Paying too early can leave you short on cash, and paying too late can damage the relationship.

2. Inventory Management

Having too much or too little inventory can cause issues with your cash flow. You don't want to be sitting on a product you can't sell, but you also want enough to bring in steady revenue.

3. Inconsistent Sales

Some businesses see fluctuations in sales depending on the time of year or if they're in a cyclical industry. Inconsistency of sales can make it hard to predict cash flow.

4. High Overhead Costs

Every business has overhead costs like employee wages, rent, utilities, and more. It's helpful to ensure that there's enough cash coming in to pay employees and the bills.

5. Expansion and Growth

A business may want to open new locations or expand in other ways, like reaching new markets. Take a look at cash flow and see if there's enough of a buffer should these plans not generate revenue as expected.

6. Customers Paying Late

Depending on the business, customers may make monthly payments or pay invoices later. If customers aren't paying on time, it can be difficult to predict cash flow.

10 Tips for Better Cash Flow Management

With all of the challenges your business may face with cash flow management, it's helpful to have some tools and tips to improve your process. You can use some of these tips preemptively or to resolve challenges as they arise.

1. Reduce Unnecessary Expenses

Cost-cutting should be part of any business strategy to help increase profits and improve cash flow. Look at your business's monthly expenses, see what's necessary and what's not, and then decide what you can cut.

When doing this audit, keep the customer in mind. “[Reduce unnecessary expenses] without compromising quality or customer satisfaction,” suggests Kamyar K.S., CEO of World Consulting Group.

2. Negotiate Payment Terms

If you're struggling with cash flow due to vendor payments, it may be beneficial to negotiate payments rather than paying late. Vendors may appreciate knowing about payment delays beforehand and working together rather than receiving unexpected late payments.

3. Improve Accounts Receivable

Customers paying late can harm cash flow, so try to find ways to encourage on-time payments. You can try offering discounts or other benefits on future purchases for early payments, and you can also develop a follow-up process if a customer is late.

4. Analyze Your Cash Flow Regularly

It's difficult to fix a problem if you don't know that it exists or if you catch it late. Develop a cash flow analysis process where you regularly look into your cash flow situation. You can use programs to generate reports to make the process easier. It's also beneficial to focus on potential areas of risk for potential cash flow issues in the future.

5. Make Cash Flows as Predictable as Possible

While this may be easier said than done, it's beneficial to make your cash flows predictable. Your regular expenses are the best place to start because they're more in your control. When it comes to customers and sales, you can try different methods to keep cash inflows as consistent as possible. For example, if you need a certain amount of sales, you can create incentives for customers and employees.

6. Prepare for the Worst

Optimism is a great attribute for small business owners, but you also need a healthy sense of concern. When looking at your cash flow predictions, create backup plans in advance. For example, if you have a great quarter of sales, you can strive to meet those numbers again but create a plan for scenarios where sales aren't as good the following quarter.

7. Have an Emergency Fund

Sometimes, you can't predict when unexpected expenses will arise. There might be a maintenance issue or a lull in sales. Having an emergency fund has helped many small business owners like the owner of Property Inspection Pros, Sol Kruk.

Kruk does this with profits from the company. He told us, “By always putting a portion of our profits into this reserve, we've built a cushion that gives us stability and peace of mind. This makes sure that our business is financially stable and ready to take advantage of chances when they come up.”

8. Manage Credit Policies

If your business gives customers credit, you can improve cash flow management by also managing your credit policies. Extending credit to customers gives them more ways to buy from you and increase customer loyalty. But, without proper guidelines and ways to have your customers pay on time, it can harm your cash flow.

9. Utilize Accounting Technology

There are a wide range of tech tools that you can use to help manage your cash flow. Whether it's popular programs like QuickBooks® or new artificial intelligence programs, many tools are at your disposal. This not only helps with automation, but it can also help reduce errors.

10. Use Credit for Large Orders

A business should use credit sparingly because it's easy to accrue a lot of debt without realizing that it's adding up. For larger purchases, it may be a good idea to finance the orders rather than paying the lump sum and depleting your cash. This is even better if you can find low interest rates.