Cash flow is vital when it comes to managing the finances of a small business as research shows that around 80 percent of small business failures are the result of poor cash flow.

Good cash flow management means delaying the outflow of cash for as long as possible while ensuring that those who owe you money pay it as soon as possible. It is important for you to prepare cash flow projections for a period of time, whether it is for next year, next quarter or next month. A sound forecast model will enable you to anticipate problems and be prepared if and when financial trouble strikes. It can also be used to develop projections for sales, costs, credit and funding. Below are a range of steps to help SMEs effectively manage their cash position:

1. Prepare a sales forecast
2. Estimate cash inflows
3. Estimate cash outflows
4. Calculate your net cash position
5. Surviving shortfalls

Step 1: Prepare a sales forecast

Cash flows are not accurate predictions into the future but rather educated guesses that take into account a number of factors such as sales forecasts, customers' payment histories and upcoming expenditures for a given period of time. You can prepare a sales forecast by using previous sales figures to arrive at a realistic estimate. You should also consider market climate and any seasonal trends or fluctuations in your industry that may affect future sales.

Step 2: Estimate cash inflows (receipts)

A cash flow projection should include cash that you have received for the chosen period. This includes money from customers, loans received, money from assets sold, interest earnings and other sources of income.

Step 3: Estimate cash outflows (payments)

The third step of creating a cash flow projection entails noting cash expected to be paid for the chosen period. This includes forecasted dates and amounts of upcoming cash outflows. Examples of cash outflows include payments to suppliers, salaries and wages, loan repayments, benefits paid, taxes, assets to be purchased, debt payments and office supplies amongst others. It is important to also include infrequent payments for the relevant period such as insurance, rates and registrations.

Step 4: Calculate your net cash position

The last step in preparing a cash flow projection is to calculate your net cash position. The formula for estimating your end cash balance is as follows:

Cash on hand at the start of the period + Estimated cash inflows - Estimated cash outflows = Net cash balance.
Your net cash balance will give you a good estimate of your business' financial position. It will enable you to see whether your firm has more incoming or outgoing money or whether your business has about the same amount of money coming in as going out. If your ending cash balance suggests that you are likely to run out of cash, you should consider taking some important steps to stop the anticipated shortfall from occurring.

Step 5: Surviving shortfalls

Many small businesses, at one point or another, find themselves in a situation where they're unable to their pay bills. If you find yourself in this situation there are a number of steps you can take to survive the shortfall.

1. Try to identify the cash flow problem as early as possible as most traditional lenders (such as banks) are more receptive to helping if you ask them months in advance.
2. Arrange for a line of credit at your bank before you fall short. This type of preplanning will allow you to borrow money up to a preset limit when you need it.
3. If your bank is not willing to help you, ask your suppliers. Most suppliers are often willing to give extended terms on a significant low-cost loan; especially if you have been a longstanding customer. Be sure to communicate with your suppliers so they are aware of your financial situation.
4. Raise cash by selling or leasing back assets such as equipment, machinery, computers or even office furniture. You can arrange for a leasing company to organise the transactions.
5. Wisely select the bills you choose to pay first. Payments such as salaries and wages are crucial. It is also important to pay key suppliers. Take advantage of a creditor's payment terms and pay on the last day bills are due or arrange to have bills paid in instalments.

Good cash flow management can often be the determining factor between a successful business and a failed one. In any business venture, cash is king, therefore it is important to understand your cash cycle and effectively manage cash coming in and cash going out during any given period.

Want to know more about managing your cash flow? Find out what not to do " read critical errors in managing business cash flow >>