Understanding and managing your cash flow is crucial, especially in the early stages of your business. Cash flow, simply put, is the movement of funds in and out of your business. It's a clear indicator of your company's ability to meet your financial obligations and immediate financial health. Understanding your cash flow is crucial; it tells you if you're generating enough income to cover your spending and provides insights into your financial stability, investment capabilities, and growth potential. This all might seem obvious, but it is amazing how many startups we come across who do not have the visibility of their weekly and monthly cash flows, putting them at risk of running out of money.
Improving cash flow means ensuring that more money is coming into your business than going out. It sounds straightforward, but achieving a positive cash flow requires strategic planning and continuous management. Here are some practical steps to enhance your cash flow:
Delayed invoicing leads to delayed payments. Ensure you bill your customers immediately after delivering a product or service. Implement a systematic follow-up process for late payments. And don’t rely on emails, get on the phone and build a relationship with your customer or finance counterpart so you can get invoices paid quickly!
Overstocking can tie up unnecessary funds. Adopting robust inventory management, e.g. “just-in-time” can help reduce inventory costs without risking running out of products to sell.
- Take longer to pay suppliers, but maintain your relationships — while it's beneficial to delay outgoing cash as long as possible, ensure you don't sour relationships with suppliers. Negotiate longer payment terms as part of a mutually beneficial arrangement (e.g. increasing minimum order quantities).
- Offer customers discounts for early payments.
- Use invoice financing options — consider various financing solutions, such as lines of credit or invoice financing, to cover short-term cash flow gaps.
Calculating cash flow is pivotal in assessing the financial health of your business. The basic formula is straightforward:
Net Cash Flow = Cash Inflows − Cash Outflows
- Cash inflows — this includes all the money that comes into your business, from sales, invoice collections, loans, and other income.
- Cash outflows — this comprises all the money going out of your business, including expenses like rent, salaries, supplier payments, loan payments, and any other business expenses.
By monitoring your cash inflows and outflows over a specific period, you can gain valuable insights into your operational efficiency, investment capabilities, and financial viability.
For information on the power of the 13-week cash flow forecast during the early phases of a company or during heavy periods of growth, click here.
A cash flow forecast is a detailed projection of your cash inflows and outflows over a future period. It helps you anticipate cash shortages, plan for upcoming expenses, and make informed decisions about investments, savings, and loans. Essentially, it's a tool for predicting your business's financial ability to cover your obligations.
Creating a cash flow forecast involves estimating your future sales, when customers will pay their invoices, and the timing and amount of your expenses. It's an iterative process that becomes more accurate with time and experience. Here are key steps to create a cash flow forecast:
- Estimate incoming cash — review your sales forecast and accounts receivable (money owed to you) to predict your cash inflows. Use historical cash collection times to estimate when money is going to come in.
- Estimate outgoing cash — list all expected payments, including operational expenses, loan payments, and planned investments. Remember, some things you pay for might be annual payments (e.g. insurance), so watch out for those big one off expenses.
- Adjust for timing — not all invoices get paid immediately, and expenses often have different payment terms. Adjust your forecast to reflect the real timing of cash inflows and outflows, and make sure you’re not paying too early!
- Review and update regularly — your forecast should be a living document, updated regularly with actual figures to improve accuracy over time.
Many businesses fall into common traps that negatively affect their cash flow.
Overestimating sales
Be realistic about your sales forecasts. Overoptimism can lead to excess inventory and cash tied up unnecessarily.
Underestimating costs and timing
Expenses often end up being higher than anticipated, and payments can come in later than expected. Plan for buffers in both areas.
Failure to adjust forecasts
Not updating your cash flow forecasts with actual sales and expense data can lead to inaccurate projections and poor decision-making.
Avoid these pitfalls by maintaining conservative forecasts, closely monitoring actual vs. projected cash flows, and adjusting your plans accordingly.
Technology can play a useful role in enhancing cash flow management through:
- Automated invoicing and collections — software solutions can automate invoicing processes and follow up on outstanding payments, reducing the time to receive payments.
- Real-time cash flow analysis — modern financial tools offer real-time visibility into your cash flow, enabling immediate adjustments to your financial strategy.
- Predictive analytics — advanced software can analyse trends in your cash flow data to predict future shortfalls or surpluses, allowing for proactive management.
Now we’re all for automating processes using software, however, beware software limitations and inflexibilities. Whilst utilising software to manage cash flow can be useful, nothing beats a good old spreadsheet to map out your logic and thinking. And if you’re using your cash flow as part of your fundraising financial model, investors still want to receive a spreadsheet so they can play with it, adjust assumptions and create scenarios.
Final Thoughts
Understanding and managing cash flow is crucial for the health and success of your startup or SME. It's about more than just survival; it's about positioning your business for growth and stability. Implementing robust cash flow management practices, calculating cash flow accurately, and developing detailed cash flow forecasts are essential steps in this process. By doing so, you ensure your business remains resilient, adaptable, and on a clear path to achieving its strategic objectives. Engaging deeply with your cash flow is an investment in your business's future, a commitment to informed decision-making, and a strategy for long-term success.
