Cash flow management can be one of the most complex challenges facing a business owner.
That’s because it takes place on several levels at once – everything from accounts receivables and payables to inventory and expense control, to even bigger questions about your business model.
“Good cash flow management starts with making financial projections and then closely monitoring your actual financial results,” says Sophie Gauthier, Director, Business Restructuring Unit at the Business Development Bank of Canada (BDC).
“To prepare financial projections, you should first think about your plans for the coming year – especially big ticket expenditures such as buying equipment or acquiring a business,” she adds. “Based on these plans, you should then come up with a projected income statement, balance sheet and monthly cash flow forecasts.”
Consider different scenarios (optimistic, most likely and pessimistic) so you can plan for the impact of each.
Your projections should also indicate your financing requirements for the coming year. With those in hand, you can approach your bankers to arrange credit lines or term loans.
It’s important to avoid the common mistake of trying to pay for longer term assets with your every day cash. This can lead to a cash shortage if revenues dip or your business keeps growing. You’re better off taking a term loan.
“As the year progresses, compare your projections to actual results on a monthly basis in order to understand the cause of variances and react properly,” Gauthier says. “For example, if sales are lower than expected, you could cut expenses, delay discretionary outlays or ask your suppliers for some breathing room.”
Investigating the cause of variances will help you zero in on where things are going off the rails and how to get back on track.
Poor profit margins can quickly lead to cash flow problems. Entrepreneurs often fail to account for all overhead costs or simply charge too little for their products or services to produce an acceptable level of profit.
5 steps to better cash flow management
1. Collect receivables as quickly as possible, even if you have to offer customers a small discount.
2. Keep a close eye on your cash flow through the month and compare month end and quarterly totals to projections.
3. Use term loans, not working capital or your line of credit, to pay for capital assets such as equipment, machinery or real estate projects.
4. Seek to extend payment terms, but remember it takes two to tango. Work on improving your supplier relationships.
5. Arrange financing ahead of time – not when cash gets tight.