During times like these, managing cash flow is more important than ever. Unfortunately, cash flows can get overlooked when business owners are busy managing their brand’s message, aggressively cutting costs, and building out services to suit new expectations or to comply with laws and regulations. Having a positive cash flow is essential to the success of any business, and owners must understand that managing cash flow is a worthwhile and necessary task. If cash flow is well managed, business interruptions will have much less of an impact, and businesses will be poised to persevere through even the toughest times.
Managing cash flow requires business owners to observe not just cash balances on hand, but the flow of cash. This can be tricky because it’s not always intuitive to track movement. If you are a beginner at managing cash flows, we recommend you read our refresher article here where we discuss best practices. Today, we’d like to discuss three of the most common cash flow management missteps.
Passively Monitoring Cash
Thinking about cash only when it comes into the business is not enough. Business owners should be thinking about cash inflows well before cash ever hits the bank account.
A simple example of actively managing cash inflows is following up on unpaid invoices. An effective small business owner knows that while the books may show revenue, if invoices are not collected, the business will not have the cash to pay operating expenses and taxes.
Proactively following up on outstanding receivables is very important for a number of reasons. It becomes more difficult to collect past-due invoices the longer they go unpaid. Customers may forget what the bill represents, or they may be upset that the bill didn’t come sooner and refuse to pay. When your customers agree to purchase a product or service, they anticipate making that payment timely, so they may not even be able to pay if they get the invoice months later.
And perhaps most importantly, collecting cash as soon as you’re entitled to it will give you the resources you need to fulfill big-picture goals like expanding into new territories, upgrading equipment, or paying down debt.
It is human nature to mentally place a project in the “completed” column once the invoice has been sent out, but this is a habit we need to change by adopting protocols that better serve us. Make it part of your weekly or month-end process to follow up on invoices. The effort will be minimal, but you should see a noticeable improvement in your cash inflows.
Actively managing cash flow does not only apply to receivables. By shortening your cash conversion cycle, you can actively manage cash in all areas of your business. You can do this by:
- Following up promptly on new leads
- Reducing the time between completing a project and sending the invoice to your customer
- Making deposits more frequently
- Shortening your payment terms (e.g. switching from net-30 to net-15)
- Changing billing policies so you can bill upfront or partway through the assignment
- Automating invoice creation
- Disbursing payments as slowly as possible (but paying on-time to avoid interest and penalties)
- Accepting new forms of payment so you can have instant access to cash
Not Utilizing a Budget
Having a budget is important, but utilizing a budget effectively is key. For a budget to be useful, you must compare it to actual results on a regular basis – every quarter or every month if you have the bandwidth – and adjust it when needed. If you see cash reserves lagging behind what you had budgeted, investigate the discrepancy. Is it something you can fix from your end? Will shortening your cash conversion cycle solve the problem? If it’s not something you can fix, you will need to adjust your budget to reflect a more realistic outcome.
If your traditional financial statement budget doesn’t provide the insight you need, consider preparing a separate budget for cash flow. This budget reflects only cash activity, showing what cash comes in and what gets disbursed in the regular course of business. Your income statement, even if you maintain your books on the “cash basis,” may show some non-cash activity like depreciation and amortization, so its use could be limited. By segregating cash from other activities, you can get a better handle on managing cash flow by seeing where you’re doing well and where you’re coming up short.
Improperly Estimating Cash Flows
Estimates will almost never be perfect, so it’s important for business leaders to be careful when relying on them. A single bad estimate may not make much of a difference, but when that bad estimate is projected out over months or years, business owners can find themselves in some deep water.
Fortunately, cash estimates can change. Rather than estimating future cash flows only during the dedicated planning phase for the year, update it as you get more information. Just like your budget, your projections should not be set in stone. They should shift and change as your operations shift and change.
To avoid overly optimistic estimates, compare your forecasts to industry benchmarks and talk to others who have good experience in your industry. This may be a business mentor or a tax advisor, and it may even be a competitor. Optimism is a great trait for business owners to have, but when that optimism causes business owners to ignore warning signs, bad decisions can be made, and the business could suffer.
Few business owners could have adequately prepared for the financial hurdles we’ve experienced so far this year, but managing cash flow and maintaining a positive cash flow are key to survival. If you have further questions about how you can better manage your cash flow, reach out to our CPAs with any questions you have.