A practical guide to financial and cash flow management to grow and be competitive! From the definition of cash flow to techniques for improving corporate liquidity.
This rule applies to any type of business. Whether your business is growing, or is in a difficult phase, knowing how to manage cash flows (or cash flow) effectively is what can make the difference between success and failure.
Companies usually produce incoming cash flows through sales, financing, and returns on investments and spends company liquidity by investing in supplies and services, utilities, paying taxes, etc…
Benefits Of A Positive Cash Flow
When there is more liquidity left at the end of a given period than at the beginning of the period in question, it means that cash flows are positive. You can therefore easily afford to:
- Pay your debts (rent, salaries to employees, payments to suppliers, bank charges, taxes…);
- Invest in new opportunities, equipment, training, and other growth opportunities for your business;
- Cope with the unexpected. Has a customer not paid within the agreed terms? Didn’t an important deal go through? Has an accident ruined some goods in stock and decreased their value? Too bad, but at least your business is safe and can continue for better times.
Signs Of Negative Cash Flow
If cash flows are negative, it means that you do not have the possibility of accessing the capital necessary to guarantee the normal running of your business, which therefore remains even more defenseless against risks or unexpected events. This situation can occur from time to time, but if it becomes chronic it can bring down your business permanently.
Better to try to prevent such situations. Make and periodically update your budget forecasts, and always keep these five indicators under control:
- large uncollected credits from your customers;
- excessive inventories;
- declining sales;
- risky expansion projects;
- loss of profit in general.
What Is Cash Flow: The Fundamentals
Let’s start from the fundamentals: what is cash flow, or what are cash flows? These are the movements of capital, real money to be clear, that enters and leaves your business: from the cash register, from the bank…
It is good practice to track cash flow consistently and monitor it cyclically: weekly, monthly or quarterly.
There are essentially two types of cash flows:
- Positive cash flows: when your receipts exceed the number of your expenses.
- Negative Cash Flows: When you spend more than you earn.
Clear enough, right?
Often, however, the difference between profits and positive cash flows is not clear. Every entrepreneur, professional, and freelancer on the face of the earth should print this definition and hang it in his office!
It is not enough to compare profits and losses to keep cash flow under control. Many other elements must be considered, such as inventory, accounts receivable, accounts payable, taxes, bank charges…
You need to consider and analyze these and other capital drivers, as well as profit and loss. Profit is defined as the simple difference between earnings and expenses. However, a good entrepreneur knows that the fact of having made a profit does not mean knowing what happened to one’s money and how the investment impacts the financial management of the next few days, weeks, or months (trivially: settling accounts due, paying taxes and rent…).
Establish Your Break-Even Point
You should always be able to predict when your business will start to be profitable.
The break-even point, in Italian “point of balance”, is the value that indicates the quantity of product/service sold necessary to cover the costs incurred. Once the break-even point is exceeded, the business begins to produce profits.
Clearly, this does not directly affect your cash flows, in fact, many businesses are technically profitable (they sell a lot, exceeding break even) but customers do not pay, leaving the company without working capital, i.e. the liquidity that allows them to cover daily business expenses.
However, calculating the break-even point is a useful first step in planning your future cash flows, a horizon to keep as a goal as we plan for growth by focusing on cash flows .
4 Ways To Solve A Cash Flow Problem
1. Short-Term Financing
A form of short-term financings, such as a line of credit, can give you the liquidity support you need to bridge the gap between the payments you need to make and those you need to collect. A credit line or an overdraft is generally the most used formula, but if recourse to these avenues is systematic, the problem is deeper and needs to be tackled with greater emphasis.
2. Long-Term Financing
Large investments, such as the purchase of equipment, real estate, or other assets necessary for your business, can be financed by long-term loans, without affecting your working capital. This type of loan allows you to spread large expenses in more or less small installments depending on the terms of the loan. You will obviously pay interest, but you will be able to preserve your working capital.
3. Speed Up The Recovery Of Your Credits
The sooner you invoice, the sooner you collect. Try to issue your invoices as soon as possible, making sure they are detailed and clear. If you are used to invoices on the 30th of each month, consider changing the system, for example by issuing an invoice as soon as the good or service is sold or provided.
In the case of important orders or new customers you don’t trust, you can offer split payments in progressive invoices, for example by requesting an initial down payment followed by other payment tranches at certain deadlines. You can also consider offering a small discount to customers who pay in advance.
Finally, make sure that the customer can pay you as quickly and conveniently as possible. For example, insert a link in your invoices where you can pay immediately by credit card or PayPal.
4. Liquidate The Cash Tied Up By The Estate
Do you have unused equipment or inventory that could expire or otherwise become obsolete and lose value? You can think of selling them, proposing special offers, discounts, sales, and timed auctions. Try to figure out the obsolescence rate of what you might be selling ahead of time so you don’t wait for it to depreciate too much.