Understanding cash flow and how to manage it - part two

Cash can often enter and exit your business at a frantic rate and for many owners of SMEs it is a difficult task to stay on top of.

We previously looked at different aspects of cash flow that are important to understand and maintain, now we will investigate cash flow and provide some tips on how you can best manage it.

What is the difference between cash flow and profit and loss?

Due to the nature of accounting it is possible for your business to be profitable and on the verge of bankruptcy at the same time. This is because profit isn't measured exclusively on cash and your profit and loss statement will include non-cash items and estimates. For example, the assets owned by your business, such as land or a vehicle, are included in your profit and loss statement but can't be used to exclusively pay for things. This further reinstates the importance of cash flow in business survival.

Cash flow statements are far more difficult to predict than profit and loss statements - especially in the case of SMEs who quite often depend on a few large customers - because despite it being easy to predict the closing of a sale, it is often hard to determine when the customer will pay their invoice.

Therefore, it is essential you make an arrangement that will work for you.  Remember, you have more control over your cash payments than you do of your cash receipts, so make sure you pay your bills on time and only early if you have sufficient cash on hand to do so.

Developing an effective cash flow management process

In the simplest of terms, the ideal way to manage cash flow is to delay any payments of money owing right up to their due date and encourage debtors to pay as promptly as possible. When projecting your cash flow you need to remember to take into account both incoming and outgoing payments and you should also identify both set and variable costs in your projections.

It is also equally important to take into account the payment history of your customers, as they will be significant in determining the cash you will have available.

It may also be of benefit to put policies in practices that will regulate the extension of credit to customers. Some key questions to ask yourself are:

  • Is it essential that a credit check be conducted?
  • Is there a set number of customers that you need to hit?
  • How quickly do you want your customers to pay and how will you ensure they pay on time?

Customers who are poor payers can often lead to bad debt, therefore you should ensure you are adequately prepared to manage your accounts receivables.

Top tips for managing cash flow:

As highlighted, cash flow is essential in ensuring your business operates at maximum efficiency. By ignoring it's importance you leave your business vulnerable long term. Below are some tips to help your manage your own cash flow management.

  • Develop a cash flow projection and ensure you monitor and update it regularly
  • Minimise bad debts through an established credit assessment procedure?
  • Establish an accounts payable policy at the outset of every credit relationship?
  • Closely manage your invoice process and collections practices
  • Re-arrange annual payments so you pay small installments frequently - this will help to smooth?out lumps in your cash flow cycle?
  • Use short term cash surpluses wisely - don't keep them in accounts that don't pay interest.

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