How to Manage Cash Flow in a Small Business?

You suddenly fall sick and visit a doctor for treatment; the doctor completes the physical examination as you narrate the symptoms.  The prescription includes advice – get a blood test done.  The test report gives an insight into several parameters, helping the doctor to fine-tune the diagnosis.

Business is all about managing resources to maximise output. Cash (or funds) is the primary input that drives a business.

A cash flow statement provides a picture of a company's liquidity position. It gives a specific view of the amount of money flowing in and going out of the company with the sources identified. The business owner (or the management) makes financial decisions based on these inputs.

Is there a similarity somewhere?

The amount of money (cash/cash equivalent) a company receives or pays out is known as its cash flow to understand specifically. There are two types, a positive and a negative cash flow.

Positive cash flow happens when the inflowing money from sales proceeds, account receivables are more significant than the outflow amount through account payable, expenses like raw material cost, employee cost.

Negative cash flow occurs when the inflowing money is less than the outflow money. Such situations spell trouble for a small business, and once a company gets into an unfavourable position, it takes considerable effort and planning to be positive again.

The cash flow statement is an essential indicator of the financial strength, profitability, and long-term outlook (of a company) and helps companies manage cash flow.  There are three primary sources of cash, and the statements can be divided into,

1)   Operational cash flow statement: Tracks a) cash inflows from the main activity of the business like sales realisation and b) cash outflows, the expenditure of funds for typical requirements, raw material, and staff cost

2)   Cash flow from Investing: Includes a) cash inflows from the sale of plant & equipment; proceeds from the liquidation of long-term investments; and b) cash outflows for purchase of plant & equipment and expenditure on long term investments.

3)   Cash flow statement from finance: Indicates a) inflows on account of debt issuance, stock, other securities, and b) outflows for the retirement of debt and stock and payment of cash dividends.

Having understood the fundamentals, let us now explore how to manage cash flow.

Issues below are common to managing cash flow in a small business or working out a survival strategy to stay afloat. The basic needs are similar.

What is the role of cash flow in business?

Cash flow is a crucial indicator and can work to keep your business going. At the same time, ignoring the signals may spell doom for your business.

A cash flow statement highlights a company's liquidity position and indicates the generation and usage of cash in a particular period, like an accounting year.

It points out when you have a negative cash flow, where your expenses override your income. The statement becomes a comforting factor when it indicates a continuous positive flow.

Several necessary actions and decisions critical to your business are dependent on proper cash flow management. Some of them are:

Short term planning

The statement helps in projecting inflow/outflow of cash in the short term (near future) based on past data. The company can plan operational obligations based on the statement.

Tracks payment areas

If a company has cleared the principal amount of a loan, the payment will not get reflected in the P&L statement. In a hypothetical situation, a company's P&L may show a profit, but once the principal loan amount is cleared, the case may turn negative; this is a critical issue that can affect the business adversely.

Information on non-operational expenditure

How much money is used for investment and other financial measures are provided - many companies use these non-core activities significantly as part of strategic planning to boost financial health?

Information on optimum cash balance

A company can ascertain whether there is a fund shortage or excess funds are idling. In either case, the general operations may get adversely affected if corrective actions are not taken. It also provides a view of the strategy of management regarding financial management.

An estimated less than 50 % of all start-ups survive beyond five years, and market intelligence indicates that a lack of funds is the chief reason. The importance of cash flow management increases several times under such a scenario. But, how to manage cash flow in business?

You can first work out a cash flow position on a monthly/weekly basis by comparing unpaid purchases / other liabilities to the dues from total sales in the month;

You can then use this information to generate a cash flow forecasting for the next month to understand the critical issues like whether liabilities are working out to be higher than sale receivables- cause for a potential crisis.

Few cash flow management tips

• Up to date account books

The foremost requirement for prudent financial management is regular bookkeeping. Only when your accounts are up to date will you study cash flow statements from the proper perspective.

• Regular cash flow analysis

A positive cash flow is necessary always to run a company efficiently and guide it along the growth path. Examining and analysing cash flow weekly or at least monthly can help in critical decisions regarding the usage of funds.

• Making the budget work

All successful companies, big or small, work with a realistic budget. When cash flow analysis is done against a realistic budget, you get a fair idea of its liabilities and estimated profits. It will also project whether the company may end up with a negative cash flow.

• Monetising unused equipment

Selling off pieces of equipment with little or no use makes room for a positive cash flow. Besides earning some money, disposing of old stuff will also free up much-needed space.

• Emergency provisions

A positive cash flow and a healthy cash balance will provide some cash reserve scope to meet unforeseen expenses.

Maintaining a healthy Cash reserve (or liquidity) provides flexibility to a business. Without cash or liquidity, profits are of no use.

A surplus (or profit) in the books without matching liquidity is of no practical use, and there are several instances of companies with book profit going bankrupt.

• Identify your business risks.

When planning based on actual market dynamics -   consider erratic customer behaviour in terms of payments, sudden orders, and cancellation (of order), an opportunity to buy additional raw materials, are typical issues to be factored in planning.

You may prepare several cash flow statements with hypothetical numbers. Once you are clear on the planning aspect and have understood how to keep cash safe, the company can easily survive the problems when it comes.

• Inventory management

Strict monitoring of finished goods inventory, raw material stock to identify slow-moving items; Based on these inputs, you can lower stock levels to release unproductive working capital to generate liquidity.

• Cost control

It is the time-tested method of finance planning. All cash outflows must be as per plan.

• Focus on cash flow and not on profit alone

A healthy cash flow is essential for the survival of the enterprise. Profits will naturally come in a company with a history of positive cash flow.

Learning to manage cash flow in business and identifying the necessary cash is vital for an enterprise for its survival and growth. Technology, innovations, ideas, and creativity may power an enterprise, but cash (funds) ultimately is the driver.  No prizes to be won for guessing the fate of the vehicle in the hands of a novice!

Also Read:

1) Top-10 Most Popular Business Ideas for Uttar Pradesh
2) Top-10 Business Ideas for Madhya Pradesh
3) Top-10 Business Ideas for Maharashtra
4) OkCredit: All you need to know about OkCredit & how it works

FAQs

Q. Monitoring regular cash flow will involve up-to-date maintenance of the books of account.  Can a small business afford additional staff costs?

Ans. Timely availability of data is crucial to the efficient management of any business. Several online companies have developed cost-effective advanced account management systems.  You can explore the options. OkCredit is a reliable company in this field with a successful product range.

Q. What are the most effective steps in managing cash flow for a small company?

Ans. a) Reducing the number of days credit to customers

b) working out delayed payments with your suppliers

c) reducing overheads, staff & others as much as possible by out-sourcing. These are difficult but possible methods; if you work hard, you may implement them.

Q. Will a bank give finance for a company with a negative cash flow?

Ans. Any cash flow statement is as of a particular period. If the negative flow is temporary, you can explain the circumstances. If it is a regular phenomenon,  you can talk to bank /financial institutions for a rehabilitation package to rescue the company.