Ensuring greater cash flow for your business means managing cash flow cycles, writes John Cradden.
One of the truisms of running a business is that it can survive for a while without sales or profits, but without cash it is doomed. Equally, it’s great when a business appears highly profitable but you still have cashflow problems that could ultimate force you to close it down.
Ensuring greater cash flow for your business means managing cash flow cycles.
“By following these principles, you can see when you expect to have a cash surplus or a cash shortfall, and put you in a stronger position to manage your cash over the year”
According to the Failte Ireland guide to managing cash flow, there are generally three cycles in cash flow:
- Seasonal variations in cash flow – sales do better in some months than in others
- The gap between selling your product and getting paid for it – do you get paid immediately or do you offer credit terms?
- The payment cycle – cash you must pay out to your suppliers and on taxes
Ideally you will collect more money than you will spend during each cash flow cycle, but there will be occasions when you’ll need to spend more than you’ll collect. It’s during these periods that you’ll need to monitor your cash flow and take action if needed.
Cash flow forecasting
Your first step should be to do a cash flow forecast. Cash flow forecasting enables you to predict the peaks and the troughs in your cash balances, and where the potential cash flow bottlenecks might be. It also enables you to plan your borrowing requirements, or to identify how much surplus cash you are likely to have at a given time. Many banks require this information when considering loan applications.
A forecast counts up the total sources and amounts of cash expected to come into your business and what your business expects to spend over the same period. There’s no hard and fast rules about how long these periods should be, but common practice would be to prepare three-month forecasts every month, with cash flows showing on a week-by-week basis.
Some recommend taking this further by preparing two cashflow forecasts: a realistic one and one showing the worst-case scenario. In both cases, you should also show the business assumptions behind cashflow statements. For instance, when do debtors typically settle, when is your corporation tax due etc. Otherwise, validating the accuracy of your cashflow statement can be very difficult.
Ensure that the income you forecast to receive relates to expected cash received (including VAT), rather than the estimated sales for the period. Similarly, make sure expenditure relates to payments (including VAT) that you expect to make, rather than invoices received from your suppliers.
By following these principles, you can see when you expect to have a cash surplus or a cash shortfall, and put you in a stronger position to manage your cash over the year. For example, plan purchases for when you expect cash surpluses and adopt a strategy of accelerating debt collection or deferring your payments to suppliers to get you through ‘cash crunches – or else plan to approach the bank for a bridging loan well beforehand.
Working capital management
Working capital refers to the finance required for the day-to-day running of your business. It’s usually calculated as the excess of your business’s current assets (such as cash, stock, and customers who owe you money) minus its current liabilities (suppliers you need to pay, short-term loans and any tax to be paid).
How much working capital you need depends on the nature of your business. For example, if you do a lot of your sales on credit, you may need a lot of working capital to bridge the gap between selling your products and getting paid for it.
Managing your working capital can help with identifying problems before they have a chance to impact on your business, such as rising interest rates, new competitors. Showing that you manage your working capital well and have good credit control procedures will help you build a good relationship with your bank for those times when you need short-term loans.
Building good relationships with your suppliers will also stand to your business. As well as sharing valuable information about your industry, you may be able to draw goodwill from them when times are tough. For example, they may be willing to take back stock you don’t need or give you extended credit terms.