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Managing Cash Flow

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Managing Cash Flow Managing Cash Flow A guide to help you broaden your understanding of how to manage cash flow in a small business This guide looks at the key elements of cash flow and working capital and how its management will help to protect the financial security of your business. Cash flow is generally acknowledged as the single most pressing concern for owners and managers of small and medium sized enterprises. It is the life-blood of all businesses and it is the primary indicator of business health. While a business can survive for a short period of time without sales or profits, without cash it is doomed. For this reason, your company’s cash flow requires careful monitoring and management. How to Make Sound Financial Decisions: Managing Cash Flow This short guide has been developed to help broaden your understanding of how to manage cash flow in a small business. The information here is designed to provide you with a general overview of the key issues on this topic and further support can be found on the Business Tools website. 1. How Cash Flow Works .................................................................................... 3 1.1 The advantages of managing cash flow ............................................................................................ 4 1.2 The difference between cash and profit ............................................................................................ 4 2. The Principles of Cash Flow Forecasting ........................................................ 5 2.1 Cash flow and working capital management ...................................................................................... 6 2.2 Advance warning of problems .......................................................................................................... 7 2.3 Advice for seasonal businesses ......................................................................................................... 8 2.4 Building goodwill with your bank and suppliers .................................................................................. 8 3. Steps you can take in your business ............................................................ 10 2 1. How Cash Flow Works Managing cash flow is all about days, but the customer may take 60 thinking ahead, because cash-flows days (or longer) because times are work in cycles. tight for them. Meanwhile you were planning to use that money to pay bills. The first cycle is usually seasonal The third cycle is your payment You probably do better in the summer cycle. months than winter months (unless you market winter activities or Some bills you have to pay products). immediately, on others you may have 30 days or longer in which to pay. This means you have to anticipate and prepare for lean periods. It’s important to remember tax payments as well and prepare for The second cycle is the gap them. between selling your product or service and getting paid for it. So, the trick is to manage these three cycles: seasonal variations in cash If you operate a cash only business flow, cash coming in from sales, and then your cash cycle is very short - you cash you must pay out to your get your money immediately. suppliers and on taxes. Ideally, you will collect more money than you will If you can transform your business into a cash-only business, you will improve spend during each cash flow cycle. your cash flow. However, there will be occasions when less money flows into your business But if you offer credit terms, then your than you are required to spend and it flow cycle will be longer. The cash is during these periods in particular danger here lies in underestimating that you need to carefully monitor cash when customers will pay you. You flows and to take corrective action, think you’ll get the money within 30 when necessary. 3 1.1 The advantages of managing cash flow The advantages of managing cash flow You will be in a position to reduce your are straightforward: dependence on your bankers and to save on interest charges. You will know where your cash is tied up. Surplus cash can be identified and invested to earn interest. You can identify potential bottlenecks and act to reduce their impact on your business. You are in control of your business and can make informed decisions for future It will assist you in forward planning. development and expansion. 1.2 The difference between cash and profit It is important not to confuse cash with Payments made during the period may profit. Profit is the difference between include VAT, which is not included the total amount of your business within the profit and loss account. revenues less all of its costs (whether You receive deposits in a period for paid or not). You may record a profit for a trading period (e.g. a month or a events that take place in another year) yet still face periods when your period. Therefore, you receive the cash business fails to generate a positive in advance of the event being recorded cash-flow. Differences between your in your profit and loss account. profit and your cash flow can arise for You delay paying your suppliers until a number of reasons, the most sometime after the period in which you common being: received, and used, their supplies. A high proportion of your sales are on credit (e.g. corporate customers), who may not pay you for a period of time. Some of your expenditure during the Therefore, you have a responsibility period relates to the purchase of not only to ensure that your capital items (such as equipment) business is profitable, but that it is which is charged to the profit and loss also cash generative. Frequent, account as depreciation over a period and properly prepared, cash in excess of 1 year, rather than in the flow forecasts will assist you to achieve month in which you pay for it. this objective. 4 2. The Principles of Cash Flow Forecasting Cash flow forecasting enables you to records or bank statements, making predict the peaks and the troughs in allowances for inflation, seasonality your cash balances. It also enables you and the outlook for tourism over the to plan your borrowing requirements, next 12 months. Be conservative in or to identify how much surplus cash your estimates of sales and when you are likely to have at a given time. people are likely to pay you. Be Many banks require this information prepared to defend your estimates if when considering loan applications. you need to approach lenders for funds The cash flow forecast totals the or bridging loans. sources and the amounts of cash coming into your business and the The quality, and the accuracy, of your types and amount of expenditure that cash-flow forecast will be enhanced by: your business incurs. The forecast Basing your forecast of income on period can be as long as you need it to realistic estimates. be, but it is normal to prepare cash- flow forecasts on a regular basis. It is Ensuring that your forecast income, on recommended that the forecast should a weekly basis, relates to expected be prepared monthly for the cash received (including VAT), rather forthcoming 13 week (three month) than the estimated sales for the week. period. The cash flows should be shown on a week by week basis. Weekly expenditure relates to payments (including VAT) that you expect to make, rather than invoices received weekly from your suppliers. forecast What you’re attempting to do in the Studying the bottom line each month in cash flow forecast is to anticipate what the cash flow forecast will tell you if your future bank statements will look your business is likely to end up with a like. The closer your forecast figures to cash surplus or cash shortfall in that the actual bank statement figures month. So the forecast puts you in a when they arrive, the better your cash much stronger position to manage your flow forecasting skills. Practice will help cash over the year. For example, you get the match closer. You can can plan purchases for months when download and adapt the Annual Cash you expect cash surpluses and spot flow Forecast template for your kind of well ahead of time those months where business from the Fáilte Ireland you may need to approach the bank website to automatically calculate (preferably well ahead of the ‘cash totals for you. You can base your crunch’) for a bridging loan to tide you figures on previous accounting over a lean period. 5 2.1 Cash flow and working capital management Having completed the cash flow If your projected cash flow indicates forecast, you then need to use it to that your cash-balance is reducing (or help you to manage your financial your overdraft is increasing) and this is affairs by: due to seasonality issues in your business, you should consider activating a sales promotion campaign Checking your actual expenditure and to improve income, and cash takings, lodgements on a weekly basis and and accelerate your debt collection comparing these with your cash flow activities. Additionally, you should forecast. If the difference between consider what opportunities are your estimates and your actual flow of available to you to reduce your costs cash is significant, you should revise during the period; and the figures in the cash-flow forecast; If you have a positive cash position over the period of the cash flow Using your cash flow forecast to forecast, you should make identify any week, or weeks, in which arrangements with your bank to your cash flow and your projected cash transfer your surplus funds into an position are negative. In such interest paying account. circumstances you could accelerate your debt collection activities, or defer making payments to creditors, in an attempt to prevent your business What is working capital? falling into a negative cash position. If this is not possible you need to inform Working capital is the financial your bank and arrange an overdraft resources that you have available to facility; you for conducting the day to day operations of your business.
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