Cash is the lifeblood of any business. A business will survive as long as its heart is able to pump enough cash through the system. 

Cashflow management is a vital part of running a commercial operation, yet business owners often don’t give it the attention it deserves. Remember, profit and cash are not the same thing. A business could be highly profitable, yet have cashflow problems.

For example, take a business that offers credit to its customers. The profit and loss account for the month may show a healthy profit based on invoiced sales, but an updated cashflow statement could tell a different story. The business may be running out of cash because debtors are slow to pay and the business has insufficient capital to fund its activities.

Therefore, the business may be under severe pressure because it doesn’t have enough cash and may be unable to pay the wages.

A business improves cashflow through:

  • Collecting cash from sales of products or services
  • Securing a bank overdraft or a term loan
  • Reducing its working capital requirement (such as agreeing better credit terms, collecting debts quicker, decreasing stock)
  • Sourcing additional capital (such as equity)

Managing cashflow

Effective cashflow management and forecasting are key to ensuring your business survives. It is considered good practice for businesses to always prepare two cashflow forecasts: a realistic one and one showing the worst-case scenario.

It is also considered good practice to always show the business assumptions behind cashflow statements. For instance, you should indicate after how many days do debtors settle, when corporation tax is actually paid, etc. Otherwise, validating the accuracy of your cashflow statement can be very difficult.

Know your business’s repayment capacity, or its ability to repay loans. Calculate your annual sources and uses of cash to stay fully accurate and up-to-date.

Remember that only items that affect cash should be incorporated in the cashflow statement. The following transactions (among others) do not affect cash:

  • Depreciation
  • Amortisation of intangible assets
  • Raising of a provision
  • Property revaluation 

Working capital cycle

The finance required for the day-to-day running of your business is known as working capital. Factors influencing working capital include:

  • The nature of the business: For example, a manufacturing business requires large amounts of working capital funding as it deals with a lot of sales on credit, while a cash business, for example a newsagent, requires minimum amounts of working capital funding. Take the example of a shop. It buys stock on credit and sells it for cash, therefore it does not have to finance debtors.
  • Length of operating cycle: The longer the cycle between sales and collecting cash for those sales, the more working capital is needed. Manufacturing businesses have a long working capital cycle, while retail businesses have a short or non-existent cycle.
  • Availability of credit: A business’s level of working capital credit depends on suppliers being willing to offer credit. New businesses can struggle to convince suppliers that they are worth taking a risk on, and may have to pay in cash. This will obviously have a negative effect on cashflow.

Improving cashflow

If you find cashflow is at a worrying level, how can you take steps to improve it?

  • Practise good debtor and creditor management: Ensure you send invoices out on time, every time. Stick to written contracts, and ensure money comes in and goes out of your business when it is due to be recieved or paid. 
  • Decrease stock: Expansion can kill cashflow, leaving insufficient working capital for day-to-day trading. By selling off stock and reducing the level of stock held, you’ll be able to boost cashflow.

Do's and don'ts

Do’s

  • Be sensible about cashflow timings. Analyse your business carefully. Have you received enough cash from debtors to pay the rent or your suppliers on time? Are any debtors overdue? Will any of the overdue debts become bad debts? Track the timing of all your incomings and outgoings, and be sure you can account for every cent that passes through your business. If you aren’t on top of this, you’ll find yourself missing payments and earning yourself a bad reputation.
  • Be wary of poor credit risks. Organise credit checks if you are not convinced of a debtor’s status. Investigating now will save you time and money later. If this becomes a problem, consider factoring. This is a process whereby you sell your debt to a third party. This is not for every business, but could help in certain circumstances.
  • Be persistent and consistent. Don’t be afraid to pursue bad debtors if you aren’t getting paid. Your livelihood depends on getting the money that you are owed, so follow up on late payments. Likewise, be consistent with your payments. You want creditors to know that you are honest and reliable. If that’s the impression you give, you will be in a far better position to secure loans and funding.
  • Ask plenty of ‘what if?’ questions. Be honest about the worst-case scenario. Understand the risks to your business, as well as the opportunities. See the ThinkBusiness.ie guide to Ratios.

 Don’ts

  • Just because cashflow hasn’t been a problem in the past doesn’t mean it won’t in the future. Businesses change, so make sure you are on top of things.
  • Don’t presume people will stick to payment terms. This goes for creditors and debtors. Plan for this, and have back-up plans in place.

3 Action Points

1

Understand cashflow management. Know your business’s working capital requirements, and separate this from your profitability. 

2

Work on improving cashflow. Analyse how cashflow could be improved for your business, and plan for future requirements.

3

Know the pitfalls. Bad cashflow management could be terminal for your business. Understand how you can work to avoid this.